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BANKERS' MONEY

A SUPPLEMENT TO
A TREATISE ON MONEY

By the same AutJior.
Principles

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BANKERS' MONEY

A SUPPLEMENT TO
A TREATISE ON MONEY

BY

J. SHIELD NICHOLSON, M.A., D.Sc.

PROFESSOR OF POLITICAL ECONOMY IN THE UNIVERSITY OF EDINBURGH
SOMETIME EXAMINER IN THE UNIVERSITIES OF CAMBRIDGE, LONDON, AND VICTORIA

LONDON
ADAM AND CHARLES BLACK

1902

SPRECKELS

PREFACE

The following chapters are based on a series of
Lectures delivered before the Society of Accountants
in Edinburgh, the Institute of Accountants and
Actuaries in Glasgow, and the Institute of Bankers in
Scotland. Some corrections have been made, and the
matter has been broken up and arranged in sections
for the convenience of the reader, but no substantial
changes have been introduced, and the work bears
throughout the impress of its origin. The success of
the book on Money and Monetary ProUems (now in
its 6th edition) has led the writer to hope that these
additional chapters may also prove useful to the same
class of readers. The treatment, as in the earlier work,
is intended to be introductory and suggestive and such
as may help to stimulate those engaged in practical
business to a wider study of the principles and
history of finance.

J. SHIELD NICHOLSON.

University of Edinburgh,
August 1902.

11211f

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CONTENTS

CHAPTER I

1. The money of the money market of the United Kingdom —
§ 2. Its practical importance — § 3. General scope of argument —
§ 4. Different kinds of material money — § 5. Representative
money — § 6. On the use of economic methods — § 7. Necessary to
separate the functions of money — § 8. Money as a general medium
of exchange — § 9. Money as a standard measure of values— § 10.
Money as a standard for deferred payments — § 11. On the meaning
of stability of value in the standard — § 12. Money as a store of
values — § 13. Resume of the argument — § 14. The definition and
meaning of " money " must vary with its monetary function — § 15,
The standard as determined by positive law — § 1 6. The medium
of exchange line as determined bylaw — § 17. Gold itself strictly
not money but money material — § 18. In monetary problems
necessary to state what meaning of money is intended Page 1

CHAPTER II

THE FOREIGN EXCI[ANGES

1. Introductory — § 2. International debts — Exports and imports —
§ 3. Real par of exchange — § 4. Trade of countries and of individual
traders — § 5. Other elements in international indebtedness com-
pared with exports and imports— § 6. Exports and imports typical
of all international debts — § 7. Traders in each country receive
payment in money of that country — § 8. Meaning and object of
foreign exchanges — § 9. The mint par of exchange— § 10, Limits
of fluctuations — Gold points — § 11. R6sum^ and illustrations —
§ 12. Favourable and unfavourable exchanges— § 13. Historical
and present importance of— § 14. Short and long exchange—
§ 15. Influence of rate of interest— § 16. Of state of credit —
§ 17. Variable effects of depreciation of currency — § 18. First
case— § 19. Second case— § 20. Third case— § 21. The silver
exchanges — § 22. Summary of results .... 22

viii CONTENTS

CHAPTER III

THE RATE OF INTEREST

§ 1, Interest on money and on capital distinguished — § 2. Illustrations
— § 3. Difficulties in definition of capital — § 4. Interest on capital
divided into PROFiT-interest and LOAN-interest — § 5. LoAN-interest
— § 6. Interaction between the two rates— § 7. Interest is a price
and subject to the laws of prices — Competition and monopoly —
§ 8. Widening of markets with progress — § 9. The supply of loan-
able capital — Production — § 10. Effective desire of accumulation —
§ 11. Security— § 12. Demand for capital, and first for unproductive
purposes—! 13. Demand for productive purposes — § 14. Forecast
— § 15. Effects of war — § 16. Interest on loanable money — § 17.
Importance of legal tender— § 18. Supply of legal tender inelastic
— § 19. The bank rate and the market rate — § 20. Interaction of
interest on capital, and interest on money as such — § 21 . Pro-
bable effects of great gold discoveries— § 22. Practical illustra-
tion Page 42

CHAPTER IV

COMMERCIAL CRISES

§ 1. Monetary and commercial crises distinguished — § 2. In monetary
transactions ultimate solvency not sufficient — § 3. DefeiTed con-
vertibility and suspended convertibility— § 4. Possible over-issue
of bank notes — § 5. Same principle applicable to other forms of
credit — § 6. Banks of deposit and banks of issue — § 7. Deposit
banks subject to little legal control — § 8. Causes of financial crises
— Insufficient reserve — § 9. The credit superstructure — § 10. Causes
of commercial crises — Over-speculation — Historical Cases — § 11.
Similarity in development — § 12. The tulip mania— -§ 13. Other
speculative manias—^ 14. Other causes — Excess of fixed capital
— § 15. Over-production — § 16. Raw materials and the seasons
— § 17. The sun-spot theory— § 18. Theory of credit cycles— § 19.
Importance of reference to history 63

BANKERS' MONEY

A SUPPLEMENT TO A TREATISE
ON MONEY

CHAPTER I

WHAT IS "money"?

§ 1. Tlie money of the money market of the
United Kingdom. — In a very able address on the
Constitution and Course of the Money Market,
delivered in 1888 by Dr Charles Gairdner, late
manager of the Union Bank of Scotland, the intro-
ductory sentences are as follows : " The money market
of the United Kingdom is an institution of great
importance and of some complexity. It has gradually
grown to enormous proportions, and embraces a find
almost equal in amount to the sum of the National
Debt. This fund is held by the banks, is practically
at call, and is repayable in gold; and yet ninety-five
per cent, of it is engaged in promoting the industries
and material interests of the country and the world,
while only five per cent, is actually held in coin." If
you consider carefully the meaning of this statement.

2 BANKERS' MONEY

it must strike you that, in spite of your familiarity
with the state of things described, it is a very ex-
traordinary statement. The fund of money of the
money market is, on this calculation, over £600,000,000
in amount ; 95 per cent, of it is apparently not in the
market at all, that is to say, not in the banks by which
it is said to be held ; and only 5 per cent, is actually
in coin. It may be added also that the total amount
of coin in the United Kingdom is only about one-
sixth of the total money of the money market as given
by Dr Gairdner, and it is not in any sense under the
control of the banks, but is being circulated from
hand to hand.

§ 2. Its practical importance. — Since, then, the
greater part of the " money " of the money market is
not metallic money, the question is, " What is it ? "
It is no doubt something very real, for, as we all know,
the abundance or scarcity of " money " affects the rates
charged by banks for advances and discounts, and in
that way afifects the whole trade of the country. When
the scarcity of money becomes extreme, we have indeed
a commercial crisis, and for the time being all the trade
of the country is thoroughly disorganised. And we
know also by experience that at times of crisis the
amount of metallic money or money material held by the
banks is of the most vital importance. In the words
of Walter Bagehot, the author of Lombard Street,
and a banker and an economist of the first rank, " All
our credit system depends on the Bank of England for
its security. On the wisdom of the directors of that
one joint-stock company it depends whether England
shall be solvent or insolvent." And if the precise

WHAT IS "MONEY"? 3

method of stating the truth seems rather overstrained,
there is no question of the central fact. Once the
real gold reserves available for banking purposes get
below a certain level — which again is variable accord-
ing to circumstances — the whole monetary system of
the country becomes clogged, and for the time almost
unworkable.

§ 3. General scope of argument. — The subject I
propose to discuss in this and the following chapters is
in reaHty "The Constitution and Functions of the
Money Market." In the first chapter I shall examine
the meaning and nature of the term " money " ; in the
second I shall examine under the title of the " Foreign
Exchanges " the interaction of the " money " of differ-
ent countries ; in the third I shall treat of the rates
charged for loans of '•' money " under the title of the
" Rate of Interest " ; and in the fourth I shall give
some account of the disorganisation of the money
market under the title of " Commercial Crises." On
each of these topics it would be much more easy to
write a treatise than a chapter, and in each of them
also the familiarity of the terms employed conceals
great difficulties. Accordingly, at the risk of appearing
too simple, I shall give most attention to the funda-
mental principles ; but at the same time, in order not
to appear too theoretical, I shall endeavour to illus-
trate the principles by reference to concrete facts of
striking importance in themselves.

§ 4. Different hinds of material money. — In dealing
with the question What is " money " ? we may begin
by a rapid survey of the various " things " that have
been in the past or are in the present actually called

4 BANKERS' MONEY

" money." You will find in the book on Money, by
the late Professor Jevons, an interesting account of a
great variety of primitive kinds of money — e.g., cattle,
slaves, tobacco, dried fish, straw mats, skins, and many
others. You will also find in the very remarkable and
learned work of Professor Eidgeway on the Oi^igin of
Currency and JVeight Standards excellent illustrations
of the beginnings of the evolution of "money." In
the course of progress the metals gradually displaced
other substances ; in the struggle for monetary exist-
ence amongst the metals, silver and gold were the
survivors ; next, in the duel between gold and silver,
for centuries silver held the supremacy ; and it is only
in the last quarter of a century that gold has obtained
the position of being practically the world standard for
material money.

§ 5. Representative money. — Long, however, before
the battle of the standards had become critical, some
of the most important " money " functions had come
to be performed by other " things," these other
"things" being embraced by Jevons under the
comprehensive term "representative" money. The
substance of all these things, if it can be called
substance, is in effect credit; and although for
certain purposes bank notes seem to have more
of the nature of metallic money than do bills
of exchange or cheques, as a matter of fact, in the
money economy of the present day, bills of exchange,
and especially cheques, are of far greater importance
than bank notes. You might without much incon-
venience abolish bank notes and carry on all internal
trade and all foreign trade by coin, cheques, and bills

WHAT IS "MONEY"? 5

of exchange, but without cheques and bills or some-
thing of the same kind our present monetary system
would be impossible. These various instruments —
these credit documents — perform most important
monetary functions ; of this fact there can be no
doubt. The latest return of the London Bankers'
Clearing-House gives nearly 10,000 millions sterling
as the amount of the cheques, bills, etc. for the year
1901.

I have said that bank notes are now of relatively
small importance, but it was not always so. The
history of Scottish banking in particular shows of
what vital importance were the one-pound notes, and
by no one has this importance been better brought
out than by Sir Walter Scott in his famous letters
on the Currency to the editor of the Edinburgh
Weekly Journal, under the pseudonym of Malachi
Malagrowther. The publication of these letters, it
may be said, preserved for Scotland its one-pound
note. The one-pound note, — this is the sum of Sir
Walter's argument, — "converted Scotland from a
poor, miserable, and barren country into one where,
if nature has done less, art and industry have done
more, than in any country in Europe, England herself
not excepted."

§ 6. On the use of economic methods, — And here,
if you will allow me, I will interject a general remark
on the study of economics. It is necessary in the
first place to get a real grip of economic methods,
and especially of the method of abstract analysis. If
you start at once with what you are pleased to call
facts, you will make no progress whatever ; you might

6 BANKERS' MONEY

as well hope to understand botany by taking at
random a barrow-full of weeds and making your own
classifications and dissections without reference to the
science of the subject. You must in economic science
in general, and in monetary science in particular, get
firm hold of leading principles, or, if you prefer, of
guiding hypotheses ; you must not be afraid of abstract
reasoning. Thorold Eogers, who collected an invalu-
able mass of materials in his great work on the
history of Six Centuries of English Prices, fell into
the most serious errors in his commentaries and deduc-
tions, simply because he despised and failed to under-
stand the abstract theory of money and prices.'^ The
corresponding work for France, also for six centuries,
by Vicomte d'Avenel, is in this respect far superior to
that of Eogers, because the author has taken the
trouble to make himself a master of theory. You
must, then, begin with theory — abstract, hypothetical
theory.

But it is equally important to observe that you
must end with facts and with history; your theory
is only preliminary. And in dealing with historical
facts, you must not expect to find them all nicely cut
and dried and ready to be ticketed with some par-
ticular form of some particular theory. Real facts
are never isolated in this way ; they are intermingled
with all kinds of other facts, and that is why you
require your analytic methods to make the separation.
And, moreover, facts of one kind being so intertwined
with facts of other kinds, you must be prepared to

* There is similar weakness in his most interesting work on the
First Nine Years of the Bcmk of England,

WHAT IS "MONEY"? 7

search in very unlikely places. Most of you will not
look naturally to Sir Walter Scott for the history of
Scottish banking, but on the important phase to which
I referred he may rank as an authority; and I may
say incidentally that there is more economic history,
that is to say history dealing with the real life of the
people, in the novels of Sir Walter Scott than in any
general history with which I am acquainted. I
apologise for the length of this digression, and turn
again to my abstract theories.

§ 7. Necessary to separate the functions of money. —
Seeing, then, that in actual usage the term money is
so variable, it is hopeless to begin with the so-called
facts ; we must take our monetary system to pieces to
discover the working ; in other words, we must consider
separately the various functions of money. We shall
then find that the reason why it is so difficult, if not
impossible, to frame a definition of " money " which
shall include all the " things " actually called " money,"
— the reason is that some of the functions of money
are best performed by some things and others by other
things. This is true even of the so-called primary
functions, and only when we have examined these
primary functions shall we be able to determine if a
simple definition of money is possible.

§ 8. Money as a general medium of exchange. — The
first great function of money is to provide a general
medium of exchange. It is usual to begin an account
of this function by reference to the inconveniences
of barter, as in the example of the prima donna on a
voyage round the world, who, in exchange for her songs
in the Society Islands, was to get a third of the receipts.

8 BANKERS' MONEY

When counted, her share consisted of three pigs, twenty-
three turkeys, forty-four chickens, four thousand cocoa-
nuts, and large quantities of bananas, lemons, and
oranges. The only method of saving this wealth was
to set the live stock to devour the fruit, and although
this may be called a primitive form of banking, it is
highly inconvenient.

After some such preliminary statement of the incon-
veniences of barter, and the insinuation that barter is
only proper for savages, it is usual again to drag up
barter from these lowest deeps and to set it on the
highest pinnacle of civilisation. We are told that all
exchange is in reality barter, that commodities pay for
commodities, and that money is only an intermediary.
That trade is incapable of development when confined
to direct barter, and also that all trade is in the last
resort barter, are both truths of the highest importance.
And both propositions being true, the appearance of con-
tradiction must be an appearance only. All the difficulty
would be avoided if it were stated that all exchange is
ultimately barter, but that " money " is in general a
necessary intermediary. To describe money as " only "
an intermediary is to suggest, at anyrate, that it might
be dispensed with. And if by " money " we mean
exclusively metallic money, that is perfectly true ; but
if we mean that the monetary function, as performed
by some representative of this metallic money, can be
eliminated and dispensed with, that is perfectly false.

You can only realise the fundamental importance of
this primary monetary function by tracing the stages of
industrial progress. The gradual substitution of ex-
change by money for exchange by barter has been one of

WHAT IS "MONEY"? 9

the greatest agencies in civilisation. Without money in
its simplest form, that is in the shape of cattle or skins
or some material thing generally desired and acceptable,
trade would have been strangled in its infancy. And
without money in its most highly developed form, that
is in the form which it assumes in banking, modern
industry would be impossible. In any just analysis
banks are as necessary to production as are ships,
railways, or factories.

But before leaving this primary function of money,
that is, as a medium of exchange, we may go one step
further. It is not necessary in modern commerce that
some credit document, such as would be taken by a
banker, should directly represent so much coin at every
transaction. Besides cheques and bills, there are book
credits, and even book credits are not necessary. It
is sufficient that the commodities to be exchanged shall
be expressed in terms of money, and in this case a
relatively small balance (if any) of money need be
transferred. In the case of international trade, indeed,
we often have cases in which commodities are directly
exchanged for commodities without the intervention of
any form of credit. In this and similar cases, however,
the monetary function passes into that of a measure of
values. Both sets of commodities are measured in terms
of money, and this is very different from simple barter.

§ 9. Money as a standard measure of values. — It
is time to observe then, secondly, that money is
required not only to furnish a common medium of
exchange, but to provide a standard measure of values,
or common measure in which all values can be
expressed.

2

lo BANKERS' MONEY

The necessity for a common measure of values
appears very early in history. Thus, in the early
medieval period, when rents were actually paid in the
shape of so much labour or so much produce, it
became customary to measure the values in terms
of money. And in our own times valuations are made
for all kinds of purposes as well as for actual ex-
changes. Thus, historically and actually, we may
separate the function of money as a measure of values
from the function as a medium of exchange. But the
two are so closely connected, that though there may
be measurement without exchange, there cannot be
exchange without measurement, that is, in the ordinary
course of modern trade.

In spite of this close connection, however, it is
important to observe that the actual medium may not
itself be the standard measure ; it is enough if it is
related to the standard as multiples or sub-multiples,
or in any exactly determinate way. At present, in
the United Kingdom, the sovereign is the standard
unit of value ; all values are measured in numbers, or
in parts of sovereigns or pounds sterling. But the
actual payments may be made by bronze, silver, notes,
cheques, or entries in books. And the unit of value
which itself constitutes or determines the standard
measure need not itself be a coin at all. Thus, in
most European countries the standard unit of value
was originally the pound of silver, but there was never
a coin of that magnitude or ponderosity. In fact, for
centuries in England, though the standard measure
was the pound of sterhng, the only coins of any
importance were silver pennies — the table, twenty

WHAT IS "MONEY"? li

pennyweights one ounce, and twelve ounces one pound,
shows the original relation of the penny coin to the
pound measure: the pennyweight was literally a
penny weight.

If all transactions and exchanges were effected
immediately, anything that is universally accepted
would serve as a standard measure of values. Thus,
for example, inconvertible bank notes, at any
particular moment, will effect exchanges just as well
as convertible notes or coins. If others accept the
notes at the same valuation in any market, that is
sufficient. But as soon as we consider the production
of things, we pass from a moment of time to a more or
less prolonged period of time.

§ 10. Money as a standard for deferred payments. —
It is this element of time which gives rise to a third
primary function of money, namely, to provide a
standard for deferred payments. Both theoretically
and practically this function of money presents the
greatest difficulties. The real meaning of any
monetary contract is liable to be disturbed by fluctua-
tions in the value of the monetary standard. Here,
again, the best and most easy example is in-
convertible paper. Suppose the notes were constantly
changing in value, and that in the course of a week
or a year you had to pay for every new purchase twice
as much in notes, whilst for your old contracts,
including your income, you only receive the old amount
of notes, obviously you would be deprived of half the
purchasing power of your money. That is the
essential evil of inconvertible paper ; it fluctuates in
value, and vitiates the real meaning of contracts. In

12 BANKERS' MONEY

extreme cases it ceases to fulfil this function of money
altogether, and monetary bargains are made on some
other basis in spite of legal prohibitions and penalties.
Now what is true of inconvertible paper in a
magnified form is true of every standard for deferred
payments in a greater or lesser degree. You make
a contract on a gold basis — you will no doubt receive
so much gold, or what represents so much gold, when
the contract matures ; but what the value of that
gold will be depends entirely on the course of prices
in the meantime. And, as a rule, if you take any
selection of representative commodities, there is some
movement in prices ; that is to say, so much gold
purchases more or less of various things and services.

§ 11. On the meaning of stability of value in the
standard. — So long as the conditions of production
and of demand are liable to change, it is impossible to
get any standard with absolute stability of value, and
the utmost we can aim at is relative stability of
value. To attain this end we may eliminate certain
common causes of fluctuation. Thus, for example, as
regards supply, it is quite clear that if you have a very
large durable stock, the variation in the annual pro-
duction will be of minor importance. The annual
supply of gold, for example, is always small relatively
in the total world's supply, unlike the annual supply
of wheat. Thus, so far, gold is a better standard
than wheat. Again, for some things there is a
fluctuating demand, and for others relatively a steady
demand ; and here again gold has the advantage
compared with other substances that at different times
have been used as money.

WHAT IS "MONEY"? 13

At first sight it seems as if the want of stability of
value in the standard itself is a very terrible thing ;
but in this world there is perhaps nothing practical
which attains the perfection of theory, and fortunately
within limits this want of perfection is under ordinary
conditions of no practical importance. Your yard
measure expands and contracts with every change in
temperature, but for ordinary purposes this is of no
importance. In the accurate measurement of time,
however, such contraction and expansion must be
allowed for, and you have great skill displayed in
making compensations in chronometers ; and similarly
in certain astronomical observations and calculations
an error in the instrument of the smallest degree may
vitiate the result, and incidentally send a big ship to
the bottom of ocean. Fortunately, as regards value, no
such precise measurements are required for practical
purposes — everything is, as a rule, done within
reasonable margins. It is only occasionally, with very
great change in the conditions of demand or supply,
that serious changes occur in the value of the money
material that constitutes the standard. On such
occasions there may be a very real disturbance of the
meaning of monetary contracts and a very real dis-
turbance of the distribution of wealth. Even in this
case, however, the evil ought not to be exaggerated.
The loss of one is the gain of another in any monetary
disturbance, and the evil only becomes serious where
the uncertainty actually dominates the volume of
trade and production.

§ 12. Money as a store of values. — To the three
primary functions of money already considered we may

14 BANKERS' MONEY

add a derivative function. Money may be used as a
store of values. In its elementary form this function
is extremely simple — it consists simply of hoarding so
much actual metal. But in the course of development
this function of money has also become much more
difficult of comprehension. To pay money into a bank
by means of a cheque is very different from putting —
according to the French idiom — little soiis into a big
stocking. In the case of the cheque, the only material
difference consists, as a rule, in the change of a few
figures in the books of one or two banks. And yet we
speak as if the money were " stored " in the bank.

§ 13. E4sum4 of the argument. — Thus, again, we
are led back to the original question propounded as
the problem of this lecture, namely. What is " money " ?
What is this " money " that I put in the bank when I
pay in a cheque, and What does the bank do with the
"money"? We may indeed ask not only What is
the " money," but Where is the " money " ?

The answer to the question " What is money ? "
which serves to cover most of the popular usages, is
the answer given in the late Professor Walker's book
on Money — " Money is that money does " — or, in other
words, anything which performs the functions of money
may be classed as money.

But then all the difficulties of the definition reappear
when we ask the further question : In order that a
thing may be classed as money, must it perform all the
functions or only one or two of these functions ? Take,
for example, concret^j cases : In this country, for
practical purposes, the gold coinage only fulfils all the
functions. Gold only is compulsory legal tender under

WHAT IS "MONEY"? 15

all conditions for the fulfilment of monetary contracts ;
Bank of England notes, for example, are not legal
tender by the bank itself, and other bank notes are
still more restricted as regards this function ; even the
other coins made of silver and bronze, though
popularly classed as money, have only a limited
acceptance — they are, indeed, " token " money, and
legally on the same footing as bank notes except for
small payments.

The sovereign, again, is, in this country, the only
standard measure of values ; it is so, however, simply
because the law has so determined. When a country
is obliged to resort to inconvertible paper, it very
often prohibits the use of gold as a standard, and by
penalties tries to make its notes the standard. If we
refer back to history we find examples of what is
called the double standard, or better the alternative
standard of gold or silver — that is to say, at the
option of the debtor a monetary contract might be
met by so much gold or so much silver, the rate
being in general determined by law. On various
grounds economists have proposed other standards, as,
for example, an amalgam of gold and silver, or notes
representing so much gold and silver.

Again, in this country gold is the standard for
deferred payments. Take the National Debt : it is
repayable in gold, though it may not be repaid for
centuries. Similarly as regards many perpetual
debentures, the interest is payable in pounds sterling —
that is to say, gold. But when we take very long
periods, changes in the value of the standard may be
of practical importance. In this case we have all

i6 BANKERS' MONEY

the difficulties connected with appreciation and de-
preciation, some of which will be considered in
connection with the ** Foreign Exchanges." To remedy
these difficulties some economists have proposed a
tabular standard. In effect, this is a composite
standard composed of a number of representative
commodities. It is assumed that the debtor will
covenant to pay not so much gold, but so much
purchasing power, and thus the amount of gold money
to be paid would vary with the course of prices.

Finally, when we consider the function of money
as a store of value, the most important store is, in
this country, the reserve of gold in the Bank of
England. Most of the rest of the money that is
deposited or stored in our banks is only "represen-
tative " money ; it is only supposed to be repayable in
gold. As a matter of fact, if all the so-called money
which is supposed to be repayable at call were
demanded at the same time, only a very small
percentage could be paid. But although all this
" bank " money could not be changed into gold at
any particular time, and although it only represents
gold in the highly conventional sense that it is re-
payable in gold, if demanded, it is not to be con-
sidered as in any sense' unreal or intangible. The
funds of the banks which are not represented by gold
are represented by other forms of property, as, for
example, by the produce and manufactures against
which bills are drawn and are taken to the banks for
discount, and also by the Government and other
securities which are really mortgages over the property
of the nation or of companies or of individuals.

WHAT IS "MONEY"? 17

It was said by Sir James Steuart, a great writer
who preceded Adam Smith, that any form of property
could be melted down into bank money. But the
aggregate amount of this *' bank " money must
always depend partly on the amount of the real
reserve available, and partly on the nature of the
demands likely to be made on this reserve. The
progress of banking in one important respect is shown
by the diminution in the proportion of gold reserve
to liabilities which it is necessary to keep, and this
again depends partly on the demands for gold for cir-
culating purposes — including transmission abroad — and
partly on the credit of the banking system as a whole.

§ 14. The definition and meaning of " money " must
vary with its monetary function, — It would obviously
be absurd to say that only the gold of the money
market is money, and still more absurd to go to the
other extreme and say that the other forms of property
pledged directly or indirectly to the banks are money.
If, then, for the last time we put the question :
What is " money " ? — As the result of our inquiry
into the monetary functions, the only satisfactory
answer appears to be that we must recognise that
there are various kinds of money, and that the
definition must vary according to the monetary
function that we are considering. In reality, instead
of trying merely to frame a verbal definition, we ought
always to make clear the different monetary functions.
And a good practical rule is, as in other similar cases
in economics, to use qualifying adjectives indicating
the Jcind of money or the kind of monetary function
to be considered.

i8 BANKERS' MONEY

§ 15. The statidard as determined hy 'positive
law. — The standard of value in any country is exactly
determined by the law of that country, and this
definition governs the interpretation of all monetary
contracts. How far the use of such a standard is
compulsory is also a matter of law, and how far the
law can be carried out depends partly on public
opinion. As a matter of fact, at the present time
most commercial contracts in this country are expressed
in terms of " money," that is to say, in terms of the
pound sterling ; but if people so desire, there is nothing
to prevent them making bargains to make payment
according to a tabular standard or any other standard.
But, as a matter of history, in the course of time the
governments of all countries beyond a certain stage
have adopted as their standard some definite amount
of gold or silver (and in some cases an alternative at
a certain rate). At the beginning of last century
England formally adopted the gold standard, and in
the last thirty years the gold standard has been adopted
to such an extent that it may now claim to be the
commercial standard of the world. The gold moneys
of the different countries are in this way related accord-
ing to the amount of fine gold they contain. In
certain countries, however, silver is still the standard,
and in others there are various legal standards which
are only indirectly or partially on a gold basis, as, for
example, the rupee in India. These other standards,
however, for the purposes of international trade, may
be reduced to terms of gold at any particular time.'^
§ 16. The medium of exchange line as determined
* Compare the chapter on " The Foreign Exchanges."

WHAT IS "MONEY"? 19

ly law. — The medium of exchange in any country
which people m.ust accept in satisfaction of a debt
when offered by the debtor is also a matter of law,
and how far its compulsion can be extended to future
contracts is a matter of Government and public opinion.
How far, as a matter of fact, people may and do accept
other means of settlement in place of legal tenders is
a matter of habit and convenience, and how far such
acceptance is final or irrevocable is a matter of law.
These various " things," which locally and temporarily
so far fulfil the function of money as a medium of
exchange, may be said to represent, or to be based
upon, standard money — that is, in most countries,
gold, directly or indirectly. Thus, gold in gold-
standard countries may also be said to be the funda-
mental medium of exchange, though in some cases the
foundation may be in bulk and value relatively
small compared with the superstructure. The actual
use of gold may be economised to a marvellous extent
by the use of " representative " money ; but it cannot
be dispensed with altogether, any more than the founda-
tion of a building.

§ 17. Gold itself strictly not money hut money
material. — Gold, then, under present conditions
certainly fulfils all the monetary functions to a degree
that is not true of anything else. But, to raise one
last difficulty for purposes of illustration, gold itself is
not money but only money material^ and therefore so
far only representative of " money." At the time of
the great Australian gold discoveries in the early
'Fifties, gold in South Australia is said to have fallen
to 45s. an ounce, and in Victoria to 60s., as compared

20 BANKERS' MONEY

with the mint price of £3, 17s. 10|-d. Of course
with open mints and no charge for coinage such a
difference could not arise, although even in London
at the present time there are on occasions slight
differences between the mint price and the market
price of gold. But this last difficulty is not raised
for purposes of explanation but of illustration. The
point is, that for certain purposes the money material
— even gold itself — must be distinguished from money.
In conclusion, then, we can only reaffirm the
position already laid down : For various purposes
the term " money " is used in various senses, which
are best indicated by qualifying adjectives. Thus we
may speak of metallic money, both " standard " and
" token" ; of 'paper money, including convertible and
inconvertible bank notes ; of " representative " money,
including not only bank notes but various forms of
bankers' credits ; we may speak of " national " money
and of " international " money ; of money in active
circulation, or of money in passive reserve ; of money
as legal tender and of money as the currency in
practical use ; we may speak of the value of money,
meaning thereby the rate of interest^ or of the value
of money, meaning thereby its exchange value, as
determined by the level of prices; and thus, finally,
we are led to consider the appreciation and the
depreciation of money, and the relative values of different
forms of money and money materials.

§ 18. In monetary problems necessary to state what
meaning of money is intended. — Accordingly, when we
are dealing with monetary problems, it is generally
necessary to lay down at the outset the meaning to be

WHAT IS "MONEY"? 2i

attached to the term " money " in the course of the
argument — a precaution of special importance in
dealing with the " quantity theory of money" Other-
wise, if we do not take this precaution, it is hardly
possible to escape confusion. And this habit of
constantly looking into the meaning of money has its
practical advantages. The whole business of banking
consists in estimating the demand for money of
different kinds for different purposes : in some cases a
demand for money may mean no more than a change
of figures in bankers' books ; but in other cases it may
mean that the Bank of England is obliged to borrow,
as on certain historical occasions, actual gold from the
Bank of France.

\_Note. — For a full development and illustration of
the argument, see the writer's Principles of Political
Economy, vol. ii. chaps, xi.-xviii.]

CHAPTER II

THE FOREIGN EXCHANGES

§ 1. Introductory. — In attempting to give in a
single chapter an account of the theory of the foreign
exchanges, it is obvious that the attention must be
mainly devoted to general principles. Those who
require practical details may be referred to Tate's
Cambist, or to the A B C of the Foreign Exchanges
by Mr George Clare. That the general theory
requires careful statement, and is not so obvious as is
sometimes assumed, is evident from Viscount Goschen's
standard work, which is still of the highest value on
account of its principles, although most of the
examples are altogether out of date.

I shall first of all explain the meaning of the terms
and the extent and limits of the fluctuations, and then
I shall notice, so far as space permits, some of the
important indirect effects on banking and trade of
certain kinds of fluctuations in the exchanges.

§ 2. International debts — Exports and imports. —
The term foreign exchanges refers to the settlement of
international debts. Accordingly, in the logical treat-

THE FOREIGN EXCHANGES 23

ment of the subject, we ought to begin with the
analysis of international indebtedness. The first
element to be considered is the amount of the exports
and imports. It is a commonplace of economic
theory that imports are paid for by exports. And if
there were no other elements in international indebted-
ness, imports could be paid for in no other way.
Either the value of the exports must equal that of the
imports, or else the trade must cease. A country that
does not itself produce gold could not go on paying for
imports with money; it must replenish its money
supplies, and it could only do so by selling exports
abroad. Suppose that a country had an excess of
imports which it could only pay for by sending money
or money material. As the country was denuded of
its money, prices would fall ; it would become a good
country to buy from and a bad country to sell to ; and
thus exports would be stimulated and imports would
be checked until the adverse balance was reversed.
In practice, in modern societies, long before the
country was denuded of its money there would be,
through the drain on the reserves of the banks, such a
check to credit that prices must fall. But the
principle is still the same : Provided exports and im-
ports are the only elements in international indebted-
ness, prices must be so adjusted that exports and im-
ports balance, or else the trade must diminish or cease.
§ 3. Real par of exchange. — The operation of this
principle is hidden by various conflicting circumstances.
As Adam Smith pointed out long ago, it is practically
impossible at any time to say what is the balance of
trade between any two countries. What is some-

24 BANKERS' MONEY

times called the " real " par of exchange, in the sense
of an equality of indebtedness, is much better called
an "ideal" or hypothetical par — a useful assumption
in certain kinds of reasoning. It is altogether different
from the " mint " par, or " nominal " par, which expresses
a definite concrete fact, as is explained later on.

§ 4. Trade of countries and of individual traders. —
Again, for simplicity of reasoning, we say that one
country — England — trades with another country —
France, just as if the two countries were run by a
gigantic trust on each side, and as if the state of
account were reckoned up and published every day.
Nothing, of course, could be further from the truth.
It was well said by Eicardo, who spent most of his
days in making money on the stock exchange and his
nights in making fame in economic theory, that every
transaction in commerce is an independent transaction.
The trade between France and England is not run by
two trusts, but by a multitude of independent
merchants.

The reconciliation between the two positions is
found in the course of prices. The merchants have
to make their bargains in terms of prices, and
prices are influenced not only by particular relative
causes but by general causes. And amongst such
general causes are the terms on which bills can be
discounted or advances from banks obtained. And, as
will be shown presently, the rate of discount depends,
inter alia, on the course of the foreign exchanges,
which again depends, inter alia, on the balance of
exports and imports, or rather on the payments that
have to be made on account of trade transactions.

THE FOREIGN EXCHANGES 25

§ 5. Other elements in international indebtedness
compared with exports and imports. — There are, how-
ever, other elements in international indebtedness as
well as exports and imports, on account of which pay-
ments have to be made. These elements I shall only
enumerate, as I must in some way economise my
limited time. You will find them very clearly stated
in Lord Goschen's second chapter; and in the page
that forms the frontispiece to Mr Clare's little book
you will see a debtor and creditor statement for London
of international transactions.

Besides exports and imports we have to take
account of payments in connection with freights, the
purchase or sale of stock-exchange securities, the
advance of loans, the interest on loans, the expenses of
governments abroad, the expenses of foreign residents,
the obligations incurred by banks, the profits of com-
missions of various kinds, and other minor elements.
You will find it useful, I think, to translate all these
various elements into the language of exports and im-
ports; that is to say, to consider what would be the
effect on the state of indebtedness if these various obliga-
tions were equivalent to or expressed by a correspond-
ing increase of exports or imports as the case might be.
This, indeed, is not only a good practical rule, but is a
necessary procedure when we seek to explain the course
of international trade ; why, for example, year after
year, the imports into the United Kingdom exceed the
exports by many millions. This undoubted fact does
not show that the imports are not paid for by the ex-
ports, but only that some of the exports are not in the
form of material commodities. Thus, for example, a

3

26 BANKERS' MONEY

freight has been well called an " invisible " export ; the
advance of a loan — i.e., the capital sum — is, so to speak,
an import of securities from the foreigner, and we must
pay for the securities by exporting more commodities ;
the interest on the loans, on the other hand, acts from
this point of view like another invisible export — now
we export, so to speak, the coupons and receive payment
in the shape of so much additional imports ; the
expenses of government or of absentees abroad may be
regarded as if we actually were obliged to pay for ad-
ditional imports to that extent — the imports being
consumed on the way ; and finally, foreigners have to
pay us, by sending us something of value — that is to
say, really by adding to our imports — on account of
our commissions in settling international transactions
of various kinds.

§ 6. Exjjorts and imports typical of all international
dehts. — It appears, then, that not only are exports
and imports the principal elements to be considered
in international indebtedness, but that other elements
may also be likened to them and expressed in terms
of exports and imports, and, indeed, they have a
precisely similar effect on the balance of indebtedness.

We are justified, then, in dealing with international
indebtedness, in taking exports and imports as typical
or representative, and in that way simplifying the
central problem.

§ 7. Traders in each country receive payment in
money of tJiat country. — If, however, it may be taken
as axiomatic that the exports are paid for by imports,
in the extended use of those terms, it is equally
certain, as a matter of common observation, that the

THE FOREIGN EXCHANGES 27

producers of these exports are paid for them in
the money of their own country, and the producers of
the corresponding imports are also paid for them in
the money of their country. It is all very well to
say that the coal exported by England is paid for by
the wine imported from France, but it is pretty
certain that the English colliers do not drink the
French wine, and the French wine-growers do not
burn the English coal. The English colliers even-
tually receive English money, and the French wine-
growers French money, for their respective productions.
Accordingly, if we carry out the same reasoning as
regards all the other exports and imports, we see
that the settlement of this international indebtedness
involves the conversion at some point or other of
French money into English money, and conversely.
The French consumers of English coal in some way
or other have to pay for it in English money, and in
some way or other to pay this money in England.

§ 8. Meaning and object of foreign exchanges. — The
way in which this is done is explained by the theory
of the foreign exchanges. " The foreign exchanges,"
to quote the old standard work,"^ " are transfers from
the money of one country to that of another effected
by the operation of Bills of Exchange."

It may, of course, happen that different " foreign "
countries have identical currencies, but the terms of
the definition do not exclude this case ; the essence is
the transfer of money power from one country to
another. The French consumer, through suitable
agents or intermediaries, is obliged, not only to change
* Tate's Cavibist,

28 BANKERS' MONEY

his francs into sovereigns, but the sovereigns must
be paid in England. If, however, every independent
transaction of commerce were settled independently,
we should have a multitude of parcels of coin or
bullion constantly flowing in about equal streams
from and to every country. England would be
receiving money for exports and sending away money
for imports. But the resources of very early civilisa-
tions were equal to avoiding this source of waste,
and the foreign bill of exchange may be traced back,
at any rate, to the middle ages.

For simplicity, it is convenient to assume that in
this method of the settlement of the indebtedness one
country is altogether active and the other altogether
passive — i.e., that one always draws and the other
accepts. Suppose, for example, that American
merchants export corn, cotton, etc. to England, and
draw for the value on the corresponding English
importers or purchasers. The bills being drawn on
London entitle the drawers to receive money there
from the acceptors. But so far they would be no
better off, for they would have to fetch the correspond-
ing gold from London. But suppose, further, that
other American merchants buy from London piece
goods of the same value as this exported corn. They
can, of course, settle their debts by sending gold, but
they can settle them equally well by buying these
bills from the exporters and sending them to
London, where they will be paid by the acceptors.
By the intervention of these bills the remittance,
to and fro, of bullion is avoided, and the American
exporters of produce receive American money, and

THE FOREIGN EXCHANGES 29

the English sellers of piece goods receive English
money.

§ 9. The mint par of exchange. — It is clear, how-
ever, that the bills being payable in pounds sterling,
and being sold for dollars, the first element in deter-
mining the price of the bill is the relative value of the
pound sterling and the dollar. This again depends
on the amount of fine gold each contains, and what is
called the mint par of exchange tells us how much of
the other country's currency contains, according to its
law, the same amount of pure metal as is contained in
our standard coin, according to our law. The mint
par is deduced from the legal definitions of the respec-
tive standard coins. If we take the pound sterling as
fixed, or as the basis, the mint par with U.S.A. is 4*866
dollars, with France 25*2215 francs, with Germany
20*43 marks.

If the foreign coins were being exchanged at the
same spot in order to be melted down, this mint par
would also give the actual rates of exchange. But
the term foreign exchanges refers primarily to a trans-
action in which a bill (say) for pounds payable in
London is sold for dollars received in America, and it
is this difi'erence of place which accounts for the
fluctuations in the rates of exchanges, or, as it is called,
the rise and fall in the exchanges.

I proceed, then, next to notice the principal causes
of these fluctuations and the limits to their rise
and fall. It is better now to pass from the simple
case of one kind of export and one kind of import,
and to include all the elements in international in-
debtedness, and, i7iter alia, the invisible exports.

30 BANKERS' MONEY

and, if I may coin a similar phrase, the " intangible "
obligations.

§ 10. Limits of fluctuations — Gold points. — Suppose,
then, at any particular time a number of people in
New York have to make remittances to London, and
that a number of other people in New York are anxious
to sell various credit documents, bills, drafts, etc., which
entitle the holders to receive money in London. If
the demand exceeds the supply, the price of these bills
(or other documents) will rise. But the limit of the
rise will be given by the point at which it will be just
as cheap for the American debtor to send actual gold
to London. This is the out-going gold point from New
York, and it may be taken as £1 = $4*8 9|- ; conversely,
if the supply of bills exceeds the demand the price
falls, and it may fall to such a point that it would be
just as profitable for the owner of the bill — the Ameri-
can creditor — to send for the gold. This is the
incoming gold point to New York, and may be taken
as £1 = $4-831

§ IL Ii6sum4 and illustrations. — To resume: The
mint par is just $4*8 6 6 = £1. If the rate rises to
$4'89j, it generally pays to send us gold ; if it falls
to $4*8 3 J, it generally pays to take gold from us.^
These gold points, or specie points as they used to be
called, for export and import cannot, of course, be fixed
with absolute precision, as they depend on the cost of
transmitting the gold, but the average or normal is

* If the dollar is taken as fixed and the ponce given as variable, the
mintparis Jl = 49i'*«d., and the gold points are $l = 49d. lor us, and
$l = 49|d. against us. If the dollar in New York would only buy 49d.
in London, it would pay to send gold ; if it would buy 49§d., it would
pay to fetch gold.

THE FOREIGN EXCHANGES 31

approximately certain, and it is only under excep-
tional conditions that these limits are exceeded.

If you refer to Mr Clare's book,"^ you will see a
diagram showing the course of the exchange at New
York per cable transfer on London for the year 1891.
In January, to begin with, the rate is low — $4*85|-,
and it rises to the maximum (the out-going gold point
from New York) in March — ^viz., $4'89j. It remains
high till the end of June, when there is a fall to the
minimum of $4*8 3| — the incoming gold point for New
York. The general course of the fluctuations in this
case is determined mainly by trade influences. The
States, as a rule, ship to us large quantities of corn,
cotton, etc. in the autumn, and from August to December
the exchanges are therefore generally favourable to the
States and, conversely, unfavourable to us. During
the rest of the year the balance is in our favour and
against America. In this particular year, however, it
also happened that London was selling in America
large quantities of American securities in the spring, so
that there was an extra demand for remittances from
New York to London.

The difficulty of giving actual concrete cases for the
purpose of illustrating the theory is that we cannot in
this way take the theory in parts and in order of
simplicity; the concrete cases generally require for
their explanation the whole of the theory and some
practical qualifications besides. And in this example,
which I chose to illustrate the effect of exports and
imports on the exchanges between New York and
London, I have introduced two terms not yet explained

* Note, p. 137.

32 BANKERS' MONEY

— namely, the term favourable, and the term cable
transfer.

§ 12. Favourable aiid unfavourable exchanges. —
What, then, is the meaning of the expression that the
exchanges are favourable or unfavourable, or for or
against a country ? The use of the terms may be ex-
plained in two ways — one partly historical, and the
other very real at the present time. If we take our
former illustration and consider the case of the Ameri-
can importer, if the exchange is below par he is able
to buy his remittance for so much less — he gives
fewer dollars for a hundred pounds payable in London.
Thus it looks as if American currency fetched more of
English currency. In former times there was always
much anxiety about the actual exchange of currencies,
and this is one historical meaning of the term favour-
able — i.e., to obtain more foreign currency than usual
for the native money. There is, however, a deeper
meaning — also historical. "When the exchange is
favourable to a country it shows, so far — that is,
omitting other elements of indebtedness — that the
exports have exceeded the imports. Under the old
ideas of the mercantile system this was considered a
favourable state of trade. " Sell much and buy little "
was considered the chief rule of the national trade
economy. It is not necessary, again, on the one side
to expose the fallacy, or on the other to indicate the
element of truth, contained in this maxim.

§ 13. Historical and present importance of — It is
plain that, so far as any advantage was obtained from
the state of the exchanges by way of trade, if the
exchange was favourable to the importer or the buyer

THE FOREIGN EXCHANGES 33

of the bill, it was so far unfavourable to the exporter or
the drawer of the bill. Probably the idea was that
the exporter would transfer any loss to his foreign
debtor. This usage, however, of the terms " favour-
able " and " unfavourable " — namely, as supposed to
indicate the balance of trade — is now, or at any rate
ought to be, only of historical interest.

But, I hasten to say, there is a sense in which the
terms, favourable and unfavourable exchanges, may
still be used with a very real meaning. Gold is a
commodity which, for many purposes, is very dififerent
from any other commodity. The gold held by the
Bank of England is of far greater importance to the
United Kingdom than is indicated by its monetary
value. If, owing to any cause, we exported suddenly
twenty or thirty millions more of commodities than
was usual at that period of the year — if, for example,
owing to the outbreak of war between China and
Japan we exported a mass of materials suitable for
the mutual destruction of these friendly states, there
might be some political protests and some interesting
lawsuits, but, on the whole, the trade of this country
would be stimulated, and possibly leap and bound.
But if, on the other hand, these wily orientals were
able suddenly and unexpectedly to withdraw from the
Bank of England twenty or thirty millions of gold,
which also is very useful in time of war, our trade,
instead of leaping and bounding, might very possibly
suffer from the depressing influence of a commercial
crisis.

It is the passage of gold from one country to another
that gives the principal general interest to the foreign

34 BANKERS' MONEY

exchanges. To the great mass of the people of this
country who are engaged in business of various kinds,
the course of the foreign exchanges is in general of no
interest whatever, except in one particular — namely,
if there is a rise or fall, in consequence, in the rate of
discount. That they see and feel. For one business
man who considers the course of the foreign exchanges,
a thousand consider the movements of the bank rate.
There are also, it is true, other indirect influences
which occasionally have far-reaching consequences and
call for careful examination. In general, however,
especially in this country, the principal interest of the
foreign exchanges is in connection with the rate of
discount.

§ 14. Short and long exchange. — And this leads me
to notice the other term which arose in my New York
illustration — namely, cable transfer. In itself this
term requires no explanation, but it leads up to a
point of importance — namely, the difference between
the short exchange or exchange at sight, and the long
exchange or after so many days' notice. This distinc-
tion also, it will be found, is closely connected with
the rate of discount.

The typical instrument for settling international
indebtedness is, as already pointed out, the bill of
exchange, which arises from an actual trade transaction.
If, then, this bill of exchange is not payable at sight,
but, say for simplicity, after three months, its present
value is subject to three months' discount. Accord-
ingly, if in New York a cable transfer on London
could be bought, say at par — i.e., if for one pound
payable at once in London 4*866 dollars would be

THE FOREIGN EXCHANGES 35

given, then for a pound payable after sixty days the
discount must be subtracted. Thus, referring to the
foreign rates of exchange in London quoted in the
Economist at the date of writing, the New York
cable transfer on London is £1 = $4-87|-, while the
long exchange at sixty days is $4'84f .

§ 15. Influence of rate of interest. — It may be worth
while to consider this case with an example in which a
remittance is sent/rom London (say) to Paris. If the
London debtor can purchase for a pound a cheque for
so many francs payable on demand, he will require for
his pound so many more francs in a bill which must
be discounted, and how many more francs will depend
on the rate of discount in Paris. Thus, in the same
number of the Economist, I find in the London course
of exchange Paris cheques are quoted at 25'12J, which
happens to be very nearly the gold point against us,
and bills at three months are quoted at 2 5 '32 J. The
principal cause of the difference is the rate of discount
in Paris.

In certain cases, moreover, the rate of interest, or
rather the relative rate, in the country which draws
the bills may be of importance in influencing the course
of exchanges. Suppose, for example, that the rate of
discount in Paris is much lower than in London, or
suppose that the Bank of England raises its rate
and that the conditions of the London money market
are such that the market rate in London rises to the
same extent, or it may be even more. What would be
the effect on the exchange between Paris and London ?
One natural and obvious result would be that Paris
bankers would wish to send money for investment in

36 BANKERS' MONEY

London at the more profitable rate, and thus the
exchange would turn — so far — in our favour. Tliis
natural and obvious effect would be intensified by a
less obvious cause. Bills drawn on London by Paris
having their present value calculated at the London
rate, would be a good investment for Paris bankers.
Thus they would compete for these bills — not for
remittance but for investment. This extra demand,
however, must so far turn the exchanges in our
favour still more, or at least make the movement more
speedy. It is, of course, the difference in the rates in
the two places which must be considered in this
connection.

As I indicated before, as regards this country, the
movement in the exchanges is generally only of
interest in connection with the bank rate. If the
exchanges turn against this country so that gold is
exported, or even if a drain is anticipated, the bank
rate is raised, and directly or indirectly this rise may
operate on mercantile advances generally.'^

§ 16. Of state of credit. — The foreign exchanges may
also be affected by the state of credit in both the
countries considered. This is obvious from the fact that
the documents used for remittance are credit docu-
ments, and our typical bill of exchange depends ulti-
mately on the credit both of the drawer and the accep-
tor. The intervention of banks also has become of late
years of more and more importance, and all banking
rests on credit. The rate of exchange between any
two centres, say London and Paris, will also be
affected by the rates subsisting between these centres

* Compare the chapter on •* The Rate of Interest."

THE FOREIGN EXCHANGES 37

and other centres with which they have transactions.
The principles applied, however, are the same, and
indeed for purposes of theory we may regard the rest
of the world as one great foreign country.

Similarly the operations of banks in adding stability
to the exchanges by creating paper for remittances to
pay for imports, which are really paid for by exports
at a later date, — those operations present no theoretical
difficulty.

§ 17. Variable ejffects of depreciation of currency. —
It seems to be otherwise, however, when we come to
the case of the depreciation of currency and its effects
on foreign trade. The problem is simple enough so
far as the actual premium on gold is concerned. If a
sovereign will buy so many francs at the rate of the
mint par, and if the francs are depreciated, the
sovereign must obtain so many more to the extent of
the depreciation. If the depreciation is considerable,
it may be said that the apparent course of the
exchanges depends mainly on the extent of the
depreciation. The other causes of fluctuation are still
there, but they are altogether hidden by the premium
on gold. There are also in this case no limits to the
nominal or apparent rise in the exchange — that is,
taking the sovereign as fixed and the depreciated
currency as variable.

So far the matter is simple enough. There is,
however, a point involved which is by no means
simple in theory, and is yet of very great practical
importance. The question is this: Suppose the
currency of a country, which was formerly on a gold
basis, becomes depreciated owing to excessive issues

38 BANKERS' MONEY

of inconvertible notes, will this depreciation of itself
tend to encourage exports or diminish exports (and,
conversely, of imports), or will it have no real effect ?
I believe that the correct answer to this problem is,
that the effect will depend altogether on the way in
which the depreciation takes place, and that the
answer must be different in the different cases.

§ 18. First case. — First, take the case in which the
notes become discredited almost as soon as they are
issued — that is to say, suppose that long before there
are such abundant issues as to cause an inflation of
prices through the increase in the quantity of currency
a premium on gold arises. What will happen as
regards exports and imports ? People exporting to
the country in question, and selling for the inconvert-
ible paper which is, we may suppose, practically the
only currency, will only receive about the same price
as before, but, owing to the premium on gold, they
will not obtain the same amount of gold to take back
or send back to their own country.

Therefore, exports to the country with the depreci-
ated notes will be checked. Conversely, exporters
from that country will sell for the old prices reckoned
in gold in other countries, and with this gold they can
purchase more currency at home, and thus there will
be a stimulus, so far, to exports from the country in
question.

§ 19. Second case. — But take now another case.
It might happen that prices in the country considered
rose more than was indicated by the premium on gold.
The Government might make its issues with great
prudence, and float a mass of this paper and gradually

THE FOREIGN EXCHANGES 39

inflate prices before any danger of inconvertibility was
suspected, and tbus without any premium on gold
arising, and later, for a time at any rate, the inflation
of prices might exceed the premium on gold.

In this case exports to this country would be stimu-
lated, and exports from it would be checked ; and the
final result would be that the adverse balance must be met
in gold ; then, as gold left the country the premium would
rise, and ultimately it is quite possible that the effect of
the depreciation might come to be exactly the opposite.

§ 20. Third case. — Take now a third case. If all
the parties concerned were practically to ignore the
depreciation, and conduct all their exchanges on a gold
basis, there would be no stimulating influence either
way. But it is very doubtful if this theoretical result
is ever attained in practice. The people who really
pay for the imports are the consumers in the country
with the depreciated paper, and the people who must
eventually receive the money for the exports from this
country are the producers there, and both consumers
and producers in the country concerned are in general
obliged to use this depreciated paper.

The foreign trader may insure himself against risk
by making his bargains on a sterling basis of exchange,
but he cannot prevent the depreciation affecting the con-
ditions of demand and supply in the internal markets
of this country, and these markets are influenced by
the extent and by the mode of the depreciation, and
thus indirectly the foreigner also must be affected.

§ 21. The silver exchanges. — The use of inconvertible
paper is of very frequent occurrence, and has important
indirect consequences. In recent years also the

40 BANKERS' MONEY

fluctuation in the rates of exchange between gold and
silver have been of even greater interest and importance.
The same principles must be applied, mutatis mutandis,
as in the case of inconvertible paper. It would,
however, be hopeless at the end of a lecture of this
kind to tire your attention by trying to show the way
in which the principles must be applied, or to discover
to which of the three cases of depreciated paper the
depreciation of silver may be likened. To those who
wish to work at a good monetary problem I can
heartily recommend the subject of the effect (if any)
of the depreciation of silver on the prices of com-
modities in gold-using countries.

§ 22. Summary of results. — As the subject treated
in this chapter is necessarily both technical and com-
plex, it may be useful if, in conclusion, I restate briefly
the principal positions.

The term "foreign exchanges" refers to the
settlement of international debts. These debts are
expressed in the moneys of the respective countries.
Accordingly, the first thing is to find out the relative
values of these moneys according to the fine gold they
contain. This gives the mint par.

Next, we note that the comsumer in one country
must in some way pay the producer in the other — that
is, he must remit money or something that will command
money — in the typical case, a bill of exchange. The
price of these bills varies with the demand and supply,
and the limits of the fluctuations are given by the
cost of sending gold or of sending for gold. This
gives the gold points or specie points.

In most cases these fluctuations in the exchanges

THE FOREIGN EXCHANGES 41

are ouly of interest to merchants directly engaged in
foreign trade, and, being within narrow limits, are of
little importance. But whenever the course of the
exchanges is such that a drain of gold sets in, or is
feared, there is a rise — and it may be a sharp and
a great rise — in the bank rate. Such a movement
may affect trade generally, and in extreme cases lead
to a commercial crisis.

Another case is also of general importance. If the
currency of one country becomes depreciated, the
premium on gold will rise to the extent of the
depreciation, and there are practically no limits to
this rise. The British dealer with the foreign country
which has the depreciated currency may make himself
safe by making his bargains on a sterling basis, but he
cannot avoid the indirect effects of this depreciation.
Under various conditions the depreciation of the
currency of a country may stimulate or may diminish
its exports. It really depends on the way in which
the depreciation arises.

A similar argument may be applied when one
country has a silver standard and the other gold.
The effect of the depreciation of silver upon the trade
of silver-using countries depends on the causes and
methods of the depreciation. The assertion that the
depreciation of a currency acts as a bounty on exports
may be true in some cases; in others, however, it
would act like a tax on exports, and in any case these
effects tend to disappear in time.

The great evil of depreciation is that with every
change in the degree of the depreciation a new set
of disturbances may arise.

4

CHAPTEE III

THE RATE OF INTEREST

§ 1. Interest on money and on capital dis-
tinguished. — It was shown in the first chapter of
this book that the term " money " is used with a
variety of meanings. If, then, we take the term
" interest " in what seems the most simple and obvious
sense — namely, as the price paid for the use of a
loan of money for a time — in order to get at the real
or underlying meaning we must decide what is to
be understood by "money "in this connection. We
find on the first inspection that very often in those
loans the " money " is merely an intermediary, and
that what is really lent and borrowed — when the
whole transaction is complete — is so much " capital."
Take, for example, the common case of the conversion
of some private manufacturing concern into a limited
company. The company, in effect, borrows so much
money from the investors and pays in return so much
interest of various kinds and under various conditions.
But this interest is only earned by converting the

or THE

UNIVERS

^ OF

THE RATE OF INTEREST 43

money into various forms of productive " capital."
The money in this case is only, to begin with, a medium
of exchange, and the essence of the loan is " capital."

In other cases, however, the primary object of the
loan is not to obtain capital for extending production,
but to obtain " money " in the sense of legal tender,
or at least in some form that will be accepted as
such — the object being to meet some prior monetary
obligation. In times of financial crisis, for example,
many houses may be perfectly solvent if only time
is allowed for realisation, but they fail simply because
they cannot meet in money their monetary obligations.
Accordingly, most recent writers on the principles of
economics have drawn a sharp distinction between
interest on loanable '^ capital " and interest on loanable
" money," although, unfortunately, writers on money
articles constantly use the terms " money " and
" capital " as interchangeable.

§ 2. Ilhcstrations. — In an examination of causes
and principles the distinction is fundamental, and it
is so also as a rule in practical business. If we take
the Bank of England rate as typical or representative
of the rate charged for loanable money as such, and
the rate on first-class securities or debentures as
typical or representative of the interest on loanable
capital, we find that there is often a considerable
difference between the two rates. Whilst interest on
capital is relatively very steady — the yield to
consols not varying perhaps one per cent, in fifty
years — the bank rate may sometimes be above and
sometimes below, and the changes are often very
frequent and occasionally violent, oscillating in the

44 BANKERS' MONEY

same period between 2 and 10 per cent. These
dififerences are not to be explained by any difference
in security or in risk. In both cases the security
for all practical purposes may be considered perfect.
I propose, then, to deal separately with these two
kinds of interest, and to notice later on the interaction
there may be between the two rates.

§ 3. Difficulties in definition of capital. — I have
used the expression interest on capital, but a very
slight application of economic analysis shows that
capital itself is even more difficult of definition than
money. It would be hopeless, by way of introduction
to a subject sufficiently complex already, to enter
into all those difficulties, but by way of illustration
I may mention the two most popular meanings.
Some people — and they may quote the authority of
Adam Smith — look on capital as wealth that yields
a revenue ; others — and they may quote J. S. Mill —
regard capital as wealth used in p^vduction. In some
cases those dififerences of definition are of no practical
importance, because the "capital" yields revenue
by being used in production ; but in other cases there
might be great dififerences between capital and non-
capital according to the definition.- The recent war
loan, for example, yields a revenue to the lenders, and,
for all we know, may yield a revenue for centuries ;
but the corresponding capital has been used for the
most part in the destruction of life and property, and
it would be too severe a strain on language, even with
a plentiful use of those convenient terms " indirectly "
and " fructifying," to include destruction by war under
the term economic production, — and cases might be

THE RATE OF INTEREST 45

multiplied indefinitely. Take, again, the borrowings
of various local authorities on the security of the
rates. The loans will yield a revenue and so far
rank as capital to the creditors so long as the cities
and towns yield sufficient rates; but it is quite
possible that, considered from the point of view of
production, the *' capital " will very soon melt away
altogether. Those examples show that the terms
" loanable capital," and consequently " interest on
loanable capital," are by no means so simple as they
appear at first sight. And the deeper we carry the
analysis, whether in theory or in practice, so much
greater do the difficulties become. Kecently the
highest legal talent of the country has been exercised
in determining what is the nature of capital and how
capital is related to dividends.

In whatever way we regard it, the answer to the
question " What is capital ? " presents difficulties in
theory, in business, and in law. These difficulties
may be partly surmounted and the nature and
meaning of " capital " and " interest on capital " made
clear by taking different cases. Capital, like money,
has different functions.

§ 4. Interest on capital divided into TROFiT-interest
and LOAiii-interest — Of VRomT-interest. — The interest
on capital as such, in which the money is only
used as an intermediary, may be divided first of
all into two great classes which we may call jprofit-
interest and loan-mterest.

Profit-inteiest arises in this way. The owner of
any form of capital who employs it in production will
expect to gain certain gross profits. He will expect

46 BANKERS' MONEY

something in the form of reward for his labour and
enterprise, which economists call wages of management
or superintendence ; he will also expect on the average
of a mass of transactions or over a period of time to
cover all sorts of depreciation of his capital — his gross
profit must provide for insurance against risk; and
besides these two elements he will expect something
by way of interest. The three elements are best
distinguished in the case of a joint-stock company.
In this case the wages of superintendence appear in the
shape of directors' fees and salaries ; the insurance
against risk is represented by the reserve fund, or it
may be by actual insurances under that name ; and
the balance which goes in dividends to the shareholders
represents the interest on their capital. This interest
again differs according to the security — e.g.^ debentures,
various preferences, ordinary shares, etc. ; but after all
allowances there remains an element which may be
called pure interest — that is, interest on capital in
which there is practically no risk and no trouble of
management, although the interest is, so to speak,
produced in the business. If any industry gets into
a depressed condition, it is quite possible that the
gross profits may not yield any interest after allowing
for management and depreciation, and, of course, the
capital may disappear altogether; but over a period
of years it may be said that the " productive capital "
of the country yields, on the whole, a certain rate of
pure interest besides the other elements in gross profit.
§ 5. \^Ok^-int crest. — Zoa^i-interest on capital is
considered from a point of view in which direct
production is of a secondary or, it may be, of no

THE RATE OF INTEREST 47

importance. People may be unable or unwilling to
employ their capital themselves, and they lend it to
others, receiving so much interest for its use. In
this case it is indifferent to the lender what use is
made of his capital ; it may be wasted by an
extravagant landlord or by an improvident government ;
but so long as the interest is obtainable from other
funds at the disposal of the debtor this makes no
difference. The interest on large amounts of capital
is paid out of the produce of rates and taxes, and
cannot be considered as earned by the productive
employment of the capital concerned ; and in other
cases the interest is really paid out of other capital
belonging to the debtor.

If, however, we leave out of account for the present
the case of foreign investments and consider one
country in isolation, it is plain that all this interest
obtained on loans must itself in some way be produced in
the country. The /(?a7?--interest may in some cases be
a simple transfer of ^rq^'^-interest, as in the case of
various companies or of private firms, so far as they
work with borrowed capital. This case is simple ;
but the loan-intQiQ^t may also come, as already
indicated, from other sources — from the general income
of the tax-payers or from the gradual dissipation of
other forms of capital. Zoan-interest of this kind
— whatever form it may assume, that is to say if it is
not obtained from the productive employment of the
corresponding capital — is of the nature of a tax upon
productive capital and industry ; and if all the capital
of a country were advanced in unproductive loans of
this kind the country would speedily be ruined.

48 BANKERS' MONEY

If the capital is sent for investment in foreign
countries, the case is in some ways similar to loans
for unproductive purposes at home. In this case
only the interest is received by the lending country ;
and thus from the national standpoint there is so far
a reduction of income as regards the profits and
wages which arise from the employment of capital in
home industries.

Consider now the causes that determine the
direction of the employment of loanable capital. It
is clear that after allowing for security, facility for
investment, and other conditions, the rate of interest
on all kinds of capital must tend to equality.

§ 6. Interaction between the two rates. — Accord-
ingly there must be a constant interaction between
loans for productive and for unproductive purposes.
If trade is flourishing, and gross profits, including
^rq/i^interest, are advancing, capital is directed to-
wards industrial concerns; and conversely, with a
depression of trade and profit-interest declining,
capital is turned to non-industrial loans or to advances
to foreign states on which the yield is a little better.

§ 7. Interest is a price and subject to the laws of
prices — Competition and monopoly, — Interest for many
purposes is best regarded as the price paid for the use
of capital. And if .interest is once looked on as a
price, it comes under the general principles determin-
ing prices. In the course of progress the tendency of
prices is to come under the influence of competition.
And if we take a rapid glance over the actual history
of industrial progress, we find that one of the most
striking results is the substitution of the principle of

THE RATE OF INTEREST 49

competition for the principle of monopoly in the
determination of interest. In old societies interest
was usually regarded as immoral and sinful, because
in most cases it represented what was extracted
by the usurer from the absolute necessities of the
borrower. Under modern conditions the rate varies
principally with the security that is oJBfered, and not
according to the particular necessities of the borrower.
The borrower might be willing for his purposes to pay
10 per cent, a-month; but if the security is satis-
factory he may have to pay less than 5 per cent, a-year.
§ 8. Widening of markets with progress. — Another
principle that becomes prominent in the course of
industrial progress is that prices are determined more
and more by wider and wider markets. In older
societies there were numbers of local markets, and
prices were mainly determined by the local conditions
affecting demand and supply. Under present con-
ditions, for many " commodities " — using the term in
an extended sense — there is a world-wide market.
The prices of wheat, of cotton, of silver — to take but
three instances — are determined by the conditions of
demand and supply all the world over. A striking
example was afforded by wheat in the year 1879.
This year was the coldest of which there is any instru-
mental record in these islands, and there was a great
failure of the harvest. So easily, however, was the
deficit met, that the price of wheat only rose to 53s. 6d.,
as compared with 51s. as the average of 1871-1880.
Even at the beginning of the nineteenth century
such a deficiency in the harvest might have doubled
or trebled the price.

50 BANKERS' MONEY

The point of the illustration is this, that the price
of loanable capital — that is, interest — in the course of
industrial progress has also come to be subject to
conditions of demand and supply all the world over,
and no longer depends on local or even national
markets. The rate of interest on loanable capital in
this country depends, to say the least, very largely
upon the rates that may be obtained in other
countries ; and with every development of the means of
communication, including the diffusion of knowledge or
the extension of publicity in the world's great markets
— with every increase in the security afforded by the
advance of international law, and of the recognition by
individuals and by governments of the sacredness or the
compelling force of contracts, — loanable capital will
come more and more under these great world-
influences.

I proceed, now, to notice very briefly some of the
principal causes affecting, first the supply, and next
the demand, for loanable capital as distinguished from
" money."

§ 9. The supply of loanable capital — Production, —
As regards the supply of capital, the causes may be
divided into two groups. First, there are all the
causes which tend to increase production or to
diminish cost. A given amount of labour and also a
given amount of coal will, with appropriate machinery,
produce more than ever before, and, in all probability,
this increase in the powers of production will continue.
Again, tlie great improvements in transport, in security,
and, I may add, in knowledge, have opened up abundant
new sources for supplies of various forms of raw

THE RATE OF INTEREST 51

material, including the raw material of food. This
process seems also likely to continue, and man's power
over nature to be further extended to a great degree.
There is also to be considered the continuous utili-
sation of waste products, and the adoption and
extension of multitudes of economies. And perhaps
the greatest cause of all — if we are to consider
the world's supply of capital — is the advance of all
the other nations on the roads made by the pioneers
of civilisation. China may follow Japan, as Japan has
followed the West.

§ 10. Effective desire of accumulation. — But whether
this enormous increase of wealth will be turned into
" capital," or will be consumed directly and unproduc-
tively, depends on a second group of causes. These causes
are mainly moral and intellectual, but they are equally
real and important. Such, for example, are the causes
which are summarised under the phrase the " effective
desire of accumulation." There can be no doubt that,
taking a wide survey, these causes tend to increase
in force. The people in civilised states look further
into the future and they make more provision for the
future. This is shown not only by the growth of all
forms of insurance, but by the growth of education
and of morality, and by the desire to rise in the social
scale. The better members of the lower social classes
strive more and more to rise into the higher, and
one potent means is by saving a certain amount of
capital.

But it is not so much on the moral as on the
intellectual side that the creation of capital is affected
by modern progress. People are willing to wait

$2 BANKERS' MONEY

longer and to take more roundabout methods to secure
their ends, and in the last resort that means they put
more and more wealth into the form of capital.

§ 11. Security. — The great cause affecting the
accumulation of capital that always appears in every
part of the inquiry is security. Security to enjoy or
to dispose of the fruits of saving is a necessary con-
dition to the creation of capital. Under present
conditions the increase of security as afifecting the
accumulation of capital may be specially observed in
two ways. First, in the countries that are in the van
of progress more and more undertakings are conducted
on a sound basis. We are apt to lay too much stress on
striking failures or gigantic frauds, but there is no
question that relatively the losses of business are less
than ever before, or the losses that occur are more
easily repaired. The ordinary increase of capital in
this country has been estimated at 200 million pounds
per annum."^

But, seco7idly, the influence of the increase of
security is still more noticeable in backward and new
countries. More and more countries are offering
security for the creation of capital, and with the
growth of security there is at once an increase in
productive power. Thus, from whatever point it is
regarded, there is no question that, as far as supply
is concerned, the tendency is for a continuous and
considerable increase of capital.

§ 12. Demand for capital, and. first for unpro-
ductive purposes. — Let us now consider demand, and,

* Such estimates are necessarily very rough, hut they suffice for
comparative purposes. See Giffen's Qrowth of Capital.

THE RATE OF INTEREST 53

in the first place, the demand on the part of unpro-
ductive consumers. Amongst these the most important
are the governments of the world, both national and
municipal. The national debts of the world are said
to have a par value of about £6000 millions sterling,
and have mainly been incurred for unproductive pur-
poses, especially for war or for armaments, and
accordingly the interest is not derived from the
productive employment of the original capital. Local
debts to a greater extent represent productive capital,
but still in this case also a large part is unproductive
— that is to say, the loans do not produce their own
interest. On the other hand, however, a large part
of this expenditure, though classed as unproductive, in
reality adds greatly to the efficiency of a nation as
regards production, and also adds to those moral and
intellectual qualities of the people which lead them to
provide more and more for the future — that is, to
create capital.

§ 13. Demand for productive purposes. — But, second-
ly, the demand for capital may be directly for pro-
ductive purposes, and this demand has increased
enormously of recent years through the growth of
joint-stock companies, which now in this country
exceed in importance private firms. The spread of
companies gathers together masses of capital which
was formerly wasted or kept idle for want of facilities
for investment, and accordingly this increased demand
largely creates the corresponding supply.

And as regards the demand for productive purposes
generally, it may be observed that every new
demand on a sound basis implies a certain surplus in

54 BANKERS' MONEY

the future — that is to say, the ultimate effect of
borrowing for production is a further increase of
supply.

§ 14. Forecast. — It appears, so far, that the supply
of capital is likely to outstrip the demand, and that the
rate of interest on capital will tend to fall. And this
general conclusion is strengthened by another considera-
tion, the influence of which is not at first sight so
obvious. There is to be considered the growth of
population. Of the great civilised nations it is only
in France that there appears to be an absolute
diminution in the sense that the deaths exceed the
births, but in other countries the rate of increase has
fallen off, and the eminent French economist and
statistician, Leroy-Beaulieu, has plausibly maintained
such a decrease is the natural result of democracy.
If, however, capital increases faster than population,
the natural result is for wages to rise and interest to
fall.

§ 15. Effects of war. — On the other hand, there is
the possibility of a great war, which would directly
increase the demand for capital and also tend to
diminish the supply. It would also indirectly, by the
shock to security, tend to raise the rate of interest.
The subject, however, is too problematical for present
consideration. I venture to observe, however, that the
recent fall in the price of first-class investments, or,
what is the same thing, the rise in the yield, has been
too readily ascribed to the South African war. The
effects of that war, whether as regards the demand or
the supply of capital or any shock to security, do not
seem of sufficient magnitude to account for the rise in

THE RATE OF INTEREST 55

interest.^ It is difficult to see why the Boer war
should have so great an effect whilst the Franco-
German war had relatively none.

I am inclined to think a more potent factor is the
greater industrial demand and the widening of the field
for investment. The gilt-edged securities have lost part
of their monopoly or their scarcity value, and there has
been a displacement of old capital and an investment
of new in all kinds of undertakings which formerly
were not available.

Thus loan-interest has moved in sympathy with
profit-interest, and the rise is due, not to any abnormal
increase in the demand for unproductive wars, but
to the increase in the yield of productive capital.
The last four years on the whole have been years of
unexampled prosperity.

§ 16. Interest on loanable money. — I have dealt at
such length with the rate of interest on '' capital " that
I have little time to consider the case of interest on
loanable " money." The most interesting questions,
however, in connection with this second case are perhaps
better treated in the subject of Commercial Crises
to be taken up in the next chapter. For the present
it must suffice if I indicate very briefly the leading
ideas; for a fuller statement and for technical
illustrations you have Bagehot's Lomhard Street and
Mr Clare's Money Market Primer, and, I may add,
the admirable little book of Professor Dunbar on
Banking.

We may begin by saying that the value of money,

* The slight effect on interest of the declaration of peace has
confirmed this view.

56 BANKERS' MONEY

in the sense of the rate charged for advances of money,
depends on the supply and the demand. But the
term " money," as we saw in the first chapter, is a very
variable and elastic term, and we must always consider
the particular monetary function or functions involved.
The " money " we are now concerned with must be
either legal tender or by custom or habit it must have
the force of legal tender. The special function of the
money of the money market is to provide means for
settling bargains made in terms of money. The money
that is strictly legal tender is far too small in amount
to make these settlements. The whole stock of legal
tender in the United Kingdom, including Bank of
England notes (issued against securities), probably does
not exceed 126 million pounds.^ Of this, again, more
than half is in actual circulation from hand to hand,
leaving some 50 or 60 million pounds for banking
purposes, and of this amount generally more than a
quarter is held by the Bank of England. At the date
of this calculation the sum due by the banks of the
United Kingdom on deposit and current accounts was
650 million pounds — that is, ten times the amount of
the legal tender available. This is what is meant by
saying that " bank " money consists for the most part
of credit; it is based on legal tender, it represents
legal tender, and on demand it is convertible into
legal tender ; but it is not itself legal tender, and the
possibility of banking rests on the fact assured by
experience that the demand for legal tender in the
ordinary course of things will be relatively small, and
can be calculated. Accordingly, the banks keep in

• Clare's Primer, p. 49.

THE RATE OF INTEREST 57

the way of till money just as much legal tender as
they think will be required ; and just as the proportion
of the kinds of legal tender required — silver, gold,
notes — is known by experience, so also is the total
amount.

It is only putting the same fact in another way
when it is said that in most trade transactions pay-
ments are made by cheques or bills. In the words of
Mr Clare, " Cheques and bills form the principal
currency of this country." A reference to the
Clearing-House Keturns shows the magnitude of the
transactions, and these returns furnish the best test of
the activity of trade.

§ 17. Importance of legal tender. — But although
legal tender forms only a relatively small part of
the currency, it is an absolutely essential part. A
certain amount is necessary for wages, retail trans-
actions, railway fares, and various payments for which
cheques — at least ordinary cheques — are not available.
In ordinary times, as I said, the amount of legal
tender required can be readily calculated and readily
obtained, but as soon as the ordinary conditions change
there is a change in the demand for legal tender.
Thus an increase in the volume and activity of
trade increases the demand directly, and any shock
to credit by diminishing the use of cheques and bills
indirectly increases the demand. In extreme cases
an internal drain of this kind may lead to a com-
mercial crisis.

§ 18. Supply of legal tender inelastic. — It will be
seen, then, that whilst the supply of legal tender is
practically limited and inelastic, the demand is liable

5

58 BANKERS' MONEY

to variations, eveu if we consider only internal trade.
But the principal demand for legal tender, or rather
for the gold on which it is based, is the foreign
demand. A foreign demand may arise suddenly in
the most unexpected way, and it may be such that it
can only be met by the export of gold. It is in this
connection, as already pointed out, that movements in
the foreign exchanges are of general importance. The
Bank of England seeks to protect itself, and also to
attract gold from other countries, by raising its rate.
And since the Bank of England practically holds the
only available reserve of gold for foreign demands, the
proportion of its reserve to liabilities is a factor of the
greatest importance in determining the rate.

§ 19. The hank rate and the marlcet rate. — For
simplicity, I have spoken as if there was at any time
only one rate charged for advances of money. It
is hardly necessary to point out that the bank rate
may differ from the market rate, and that in
practice there are great differences in market rates —
according to the security offered, the class of business,
the condition of the loan, and other circumstances.

§ 20. Interaction of interest on capital, and interest
on money as such. — Although the rate of interest on
capital as such is best distinguished from that on
money as such, there is an interaction or a sympathy
between the two rates. If the rates obtainable for
money are low, purchases of first-class securities are
increased, partly for the better interest and partly
for the probable rise. A low rate also specially
stimulates speculation for the rise on the Stock
Exchange, if other conditions are favourable, But a

THE RATE OF INTEREST 59

rise in the price of securities, with fixed interest, is
the same as a fall in the rate of interest. Conversely,
with higher rates for money as such, securities are sold,
and the fall is again hastened by Stock Exchange
speculation. Still, it is evident that a large part of
the holdings of banks is of the nature of a docu-
mentary reserve, and although speculation on the
Stock Exchange, whether for the rise or fall, is
generally affected by the bank rate, it depends much
more on other influences. Thus for long periods
there may be a considerable difference betvreen the
two rates — namely, the interest on capital, and the
interest on money as such.

§ 21. Probable effects of great gold discoveries. — I will
conclude with a brief notice of one point of special
interest at the present time. We have seen the
fundamental importance of the gold reserve in the
Bank of England, and of the effects of movements in
that reserve on the rate of discount. It might then,
at first sight, be thought that the annual supply of
gold from the mines would be of fundamental import-
ance: so that with a falling off in supply discount
rates would rule high, and with an increase there
would be a fall. There is, however, no such simple or
necessary connection. We may take for illustration
the recent changes in the production of gold.

During the last quarter of a century the supply of
gold has doubled, and it is quite possible that during
the next quarter it may again be doubled. The ques-
tion is. What will be the probable effect on the rate of
interest on loanable money ? The answer, I think,
depends on the way in which the supplies are used.

6o BANKERS' MONEY

If a large part of the new gold were constantly added
to the money market, so far the increase of supply
would tend to lower rates. But the further question
arises, Who is to keep the gold in the market ?
The gold of itself is as barren a metal as ever it was,
and it is also as heavy and as inconvenient for large
payments. The banks, including the Bank of
England, will not be at the expense of keeping more
gold than they require as reserve, and people will not
use more than they are accustomed to as currency.
Thus the new gold must be forced into circulation,
not necessarily in this country, but in some part of
the commercial world. The natural effect will be to
raise prices, and in that way to stimulate trade. This
stimulus to trade may again lead to a rise in the rate
of discount.

Similarly, a falling ofif in the supply of gold tends
to lower prices, and so to depress trade, and in that
way indirectly a diminution in the production of gold
may lower the rate of interest, as was the case
twenty-five years ago. There are, no doubt, as in
all these monetary questions, other counteracting and
disturbing elements. The depreciation of silver had
very great effect, in my opinion, in lowering prices,
and also in promoting the useless hoarding of gold by
France and other countries. It is quite possible, now
that silver has lost its monetary influence, with the
increase in the natural supplies of gold, there will be
also some unlocking of these great hoards, and thus a
still greater rise in general prices. Such a fall,
however, in the exchange value of gold as is indicated
by a rise in general prices, may be accompanied by a

THE RATE OF INTEREST 6l

rise in the rate of interest, unless counteracted by the
other causes indicated.

§ 22. Practical illiistration. — In conclusion, this case
may be used to illustrate the general argument of this
paper.

At first sight nothing seems more natural than to
say: Interest means the price paid for the use of
money ; gold is money, and therefore if the supply of
gold is increased, the supply of money also is increased,
and therefore the rate of interest will fall. This argu-
ment, however, which at first sight seems so simple
and plausible, on analysis is full of difficulties, not to
say full of fallacies.

We must first of all distinguish between interest
on "capital" and interest on "money." If we take
account of all the capital of the world on which interest
is paid, the gross total must be reckoned by thousands
of millions sterling. This interest arises in many
ways : it may be definitely earned in production or in
the case of industrial companies, or it may be paid out
of taxes, as in the case of the interest on national
debts. But as the result of competition, what may be
called the pure interest — that is, after allowing for
risk, depreciation, management, etc. — the pure interest
on all these multitudinous forms of capital tends more
and more to equality, or the differences become less and
less throughout the commercial world.

Suppose, then, that the amount of gold is increased
by 50 million pounds a-year, what is this 50 million
pounds added to these thousands of millions ? It is
evident, then, that the argument, from the increase of
the supply of " capital," falls to the ground.

62 IBANKERS' MONEY

If, however, we carefully separate " capital " from
" money," it is no doubt true that the amount of loan-
able money is of much smaller dimensions. But even
loanable money embraces more than legal tender, and
legal tender includes more than gold. The advances
made by banks consist of a relatively small amount of
legal tender and a still smaller amount of gold itself.

Why, then, should an addition to the supplies of
gold from the mines lower the rate of interest on loan-
able money ? It is well known that during the last
twenty-j&ve years the Bank of England rate has been
for months together at the official minimum of 2 per
cent., and the corresponding market rate has been lower
still. And it is noteworthy that the rates were lowest
when the annual production of gold was lowest. No
doubt the adequacy of the ultimate reserve of gold
held by the Bank of England is of the greatest import-
ance to our credit system ; but the amount of that
reserve has very little connection with the annual pro-
duction of gold, and the annual production of gold
has still less connection with the rate of interest.

[Note. — Compare Principles of Political Economy^
vol. ii. chap, xxii.]

CHAPTER IV

COMMERCIAL CRISES

§ 1. Monetary and commercial crises distinguished. —
The title of this chapter is " Commercial Crises," but in
accordance with common practice the term is used as
also covering crises that are in the main monetary or
financial. As a matter of history, in most cases,
though not in all, crises have been both commercial
and financial. For purposes of analysis, however, it is
best to consider the two cases separately.

I shall deal first with monetary crises, and for
guidance in this part of the subject I shall ask you
to accept two principles, the importance of which has
been abundantly proved by experience.

§ 2. In monetary transactions ultimate solvency not
sufficient. — The first principle is this, namely —

In banking, and more generally in monetary
transactions, ultimate solvency is not sufficient. No
one doubts for a moment, and even in the most severe
crises no one has doubted, the ultimate solvency of
the Bank of England. Of this one very striking

63

64 BANKERS' MONEY

proof may be offered. In each of the three great
crises which followed the passing of the Bank Charter
Act of 1844 — namely, in 1847, in 1857, and in 1866—
this Act was suspended by the authority of the
government of the day. Now what is the meaning of
the suspension of the Act ? In effect it amounts
simply to giving permission to the Bank of England to
issue more notes without a corresponding increase of
gold. If there had been any doubt of the ultimate
solvency of the Bank of England, the remedy would
have seemed like the joke in Furwh, in which the
young lady meets an overdrawn account by sending
her banker another of her cheques payable to himself
by himself. But, as a matter of fact, the suspension of
the Act, in two cases indeed the mere announcement of
the suspension, was sufficient to restore confidence and
allay panic.

Again, to come to our own times, for a long time
past the Bank of England has held a reserve of gold —
for the notes in the banking department can be
immediately converted into gold in the issue depart-
ment, — the Bank has held a reserve equal to 40 or 50
per cent, of its deposits. In any ordinary bank such a
proportion of reserve would seem ridiculously large,
even if the term reserve were extended to cover much
more than gold. But the Bank of England is the
bankers' bank, and although in banking cash and legal
tender may be economised to a wonderful degree, in
certain cases for certain purposes they are essential.
Sometimes nothing but gold itself will suffice, and
practically the only reserve of gold is in the Bank of
England.

COMMERCIAL CRISES 65

§ 3. Deferred convertibility and suspended conver-
tibility. — The second principle I ask you to apply is
really only a special case of the first — namely, that
deferred convertibility is not the same thing as
immediate convertibility, and suspended convertibility
is not the same thing as payment on demand. The
case which used to be of most importance was the
case of bank notes. For a long period bankers'
advances were made for the most part in bank
notes, and even fifty years ago it did not seem
so preposterous as it would now to suppose that
monetary crises would be avoided by the proper regu-
lation of the issues of bank notes. That was the idea
by which the Bank Act of 1844, and the corresponding
Act for Scotland of the next year, were passed.

§ 4. Possible over-issue of bank notes, — The framers of
the Act of 1844 did not mean simply to secure the
absolute convertibility of the notes ; above all, they
wished to prevent excessive issues. Such excessive
issues, they supposed, caused an inflation of credit and
an inflation of prices, and ultimately led to a crisis.
This idea was the subject of a prolonged controversy,
which only ceased because bank notes came to be a less
and less important part of the credit system, and the
Bank of England notes in active circulation positively
declined in spite of the growth of trade and popula-
tion.

§ 5. Same principle applicable to other forms of
credit. — But the fundamental idea is by no means
dead, though the application must now be different.
Those who opposed this " currency principle," as it was
termed, or minimised its importance, maintained that

66 BANKERS' MONEY

if the notes were convertible on demand there could
not be an excessive issue. To which the supporters of
the stringent limitation of issues by law replied, in
effect, that the notes might not as a matter of fact be
presented for payment — that as prices rose, more
might be circulated, and thus that a crisis would
eventually be more severe. This view gained the day,
and, as I said, the Bank Act of 1844 was passed to
prevent crises by limiting the issues of bank notes.
Deferred convertibility is usually taken to mean at the
option of the debtor ; the peccant banker undertakes
to cash his notes as if they were letters of exchange
payable after so many days or months. Deferred
convertibility of this kind was soon shown to be full of
danger, witness Scottish banking in the eighteenth
century. But there may also be deferred convertibility
simply through the inaction of the creditor ; the point
is, that if the notes are presented for gold, gold will be
given, but they are not, as a matter of fact, presented.
And indeed the profit of banking for a long time
depended mainly on this deferred conversion.

This source of profit may be quite sound in practice,
as is proved by experience. At the same time, how-
ever, every civilised State has deliberately imposed
limits on the issues of bank notes ; though the
limitation has been achieved in very different ways —
as, for example, it is different in England and in
Scotland. Time will not allow me to enter into the
reasons in detail, but the reference to the universal
consensus of opinion ought to be sufficient. Con-
vertibility in itself is not thought to he a sufficient safe-
guard against the over-issue of hank notes.

COMMERCIAL CRISES 67

But what, it may be asked, is the bearing of the
argument on commercial crises under present con-
ditions, when not only issues of bank notes are
limited, but the very use of notes is of minor
importance ? "^^ The answer is, that the same prin-
ciples apply in the case of deposit banking and
cheques ; the notes have been taken for illustration
because they are the simplest form of credit
instruments.

§ 6. Banks of deposit and banks of issue. — In
deposit banks, just as in banks of issue, in the first
place ultimate solvency is not enough ; and in the
second place the mere fact that cheques are all
nominally payable in legal tender on demand is not
enough to prevent the unwise extension of credit, and
as a consequence excessive speculation and inflation.
And yet in this country bankers are practically left to
themselves in the management of their deposits,
advances, and reserves ; and whilst the issues of notes
are so strictly regulated, the use of cheques is, from
the same point of view, altogether unregulated.

In some countries deposit banking has been the
subject of legal regulation — notably in the United
States — and the want of regulation in this country
does not show that there are no dangers in freedom.
The system has grown up under various influences
instead of being a logical application of principles.
The absence of legal regulation may show either that

* " The balance-sheets for December 1887 of six English banks of issue
selected at random show liabilities of £200,000 on notes (compared
with £360,000 in 1844) against no less than seven and a half millions
on current and deposit accounts." — Clare's Money-Market Primer,
p. 15.

68 BANKERS' MONEY

the banks are to be trusted if left to themselves, or
that legal control is too difficult to manage or to
introduce. Let me again refer to the Bank of
England and the account of its functions and position
as given in that classic work, Bagehot's Lombard
Street.

§ 7. Deposit hanks subject to little legal control. —
The essence of the argument is to show the delicacy
and the danger of the present system. No writer has
ever made so clear the narrow foundation of our
present credit and banking system, and the important
part played by the Bank of England, which, strictly
speaking, is not a State bank, and the governor and
the directors of which are not bankers, but merchants
engaged in other businesses. And yet the moral of
Bagehot's argument, his general practical conclusion, is
not that law and government should at once put an
end to such an anomalous state of things, but simply
that public opinion should impress on these directors a
sense of responsibility, and that some changes should
be made in the appointment of the governor and
directors so as to admit of greater permanence in the
executive, and an admixture of trained bankers. But
of legislative control and legal rules for the manage-
ment of the reserve and deposits, there is not a word.

Well, then, the mere fact that deposit banking is
left practically free in this country does not show that
it is not liable to danger, but simply that under
present conditions the danger is not such as can be
met in fact by legislative control. The simple truth
is that, as in so much of our political and commercial
system, so in the most important part of our bank-

COMMERCIAL CRISES 69

ing, we rely on the system of national liberty, and
we trust more to historical growth than to the logical
application of principles.

§ 8. Causes of financial crises — Instcfficient reserve. —
A financial crisis may arise, broadly speaking, in
two ways. In the first place, the ultimate reserve
may prove insufficient to meet a sudden strain.
Such a strain may arise from events occurring in some
foreign country — the outbreak of war, a political
revolution, or it may be the failure of some foreign
banking system. In the past the reserve kept
was inadequate, and in times of peril it was mis-
managed. This mismanagement of the reserve, if not
the cause, was an aggravation of crises. At present
the amount is larger, and measures of precaution are
taken much sooner; and last, but not least, in times
of pressure assistance is afforded more readily when the
ultimate security is undoubted. In fact, under present
conditions, it seems at first sight hardly conceivable
that even a foreign drain could be dangerous to the
Bank of England, whilst any home drain, it may be
thought, could be met by the suspension of the Bank
Act and the issue of Bank of England notes.

But the stability of our present system is by no
means perfect. It is now more than a quarter of a
century since Bagehot described the dangers of our
one-reserve system, and yet at this very time the
London bankers are still discussing the best means of
diminishing these dangers. There is, fortunately, no
question that as regards the management of reserves
— especially the reserve of the Bank of England —
there has been immense progress since 1866. So

TO BANKERS' MONEY

great, indeed, has the improvement been, that, in spite
of the Baring crisis, it is seriously maintained by good
authorities that crises from this source are no longer
to be feared. Seeing, however, that it is little more
than ten years since the Bank of England was borrow-
ing gold from the Bank of France and from Eussia,
this complacency is rather premature. In these days
nothing is secure from the attack of combined specu-
lation. So far back as 1866 Overend & Gurney tried
to embarrass the Bank of England by the sudden with-
drawal of three millions. It is, at any rate, not beyond
the range of possibility that the banking system of
this country might be attacked by some great specu-
lative combination in what is generally considered its
most vulnerable part.

§ 9. The credit superstructure. — But there is
another source of danger. The danger may arise,
not in the reserve, but in the credit superstructure.
No doubt, here also banks have learned from experi-
ence, and they are much more prudent than was
formerly the case. Advances are made on better
security — in the widest sense of the term — and the
funds of the banks are kept more under control. But
in a system which rests largely on the good faith and
the sound judgment of hundreds and thousands of
people, how can we be sure that some gigantic fraud,
or at least some disastrous error of judgment, will not
be perpetrated ? It is on this point that the warning
of history is most clear and convincing — and not
only ancient history, but history that has been
imprinted on the minds of living men.

Even granting that the management of the reserves

COMMERCIAL CRISES 71

were perfect, that is only part of the business. There
is also the danger of excessive competition for business,
and the advance of the funds of the banks or of one
or more of them beyond the proper range of banking
securities — there is the danger of over-confidence, of
ignorance, and of fraud. Owing to the close inter-
dependence of every part of our credit system, any
failure on a large scale may bring down firms that
are in no way to blame. No doubt the businesses
that are weakest fail the soonest, but the strongest
may be unable to bear the strain. And the losses
incurred may be such that even the ultimate solvency
is not secure. It is true that in banking, conducted
on the principles confirmed by experience, there ought
to be no danger of ultimate solvency. A bank can
apply almost indefinitely the method of dividing the
risk, just as an insurance company may itself insure
against certain risks by re-insurance. It is true,
however, that the principle of insurance is not always
so easy of application in banking as it is in life insur-
ance. In times of a great plague the life insurance
companies have to meet many claims for deaths, but
in times of a great panic banks must meet claims of
people who think they are going to die. As we all
know, banks have failed in the past and in all prob-
abihty will fail in the future, though not to the same
extent. The principal danger of banking arises at
present, not with reference to ultimate solvency, but
with reference to immediate demands in times of
sudden discredit or alarm. And in this connection it
may be observed that although the shock only lasts a
short time the recovery may be slow, and during the

7a BANKERS' MONEY

process of recovery a strain may be imposed on
industry generally — that is to say, a crisis financial in
origin may in its effects become commercial.

§ 10. Causes of commercial crises — Over-speculation —
Historical cases. — It is time, however, to observe
that crises may arise from causes that are primarily
commercial and in which the financial results are
secondary. I pass on, then, to consider commercial
crises in the more special sense of the term. If we
look back on the history of commercial crises, we often
find that they begin with a hond-fide expansion of
trade and industry. Such an expansion may be due
to the adoption on a large scale of new methods of
production and of transport. Thus, at the end of the
eighteenth century, so many changes were introduced
that the period is often spoken of as the Industrial
Eevolution. The crisis of 1793 was preceded by a
bond-fide expansion of trade consequent on the increased
use of machinery for manufacture and improvement
in transport by the greater use of canals.

This hond-fide development of industry was accom-
panied by over-speculation and the undue extension
of credit. The crisis was precipitated by political
causes, especially the war with France. It was
marked by many failures of country banks and a dis-
trust of credit documents. The difficulty was met to
some extent by the issue of exchequer bills, but
ultimately a continuance of the same unfavourable
conditions led to the suspension of cash payments by
the Bank of England, and Bank of England notes
remained inconvertible till 1819.

The principal cause of the crisis of 1847 was

COMMERCIAL CRISES 73

mainly due to the great development of railways.
Twenty years before the capital expenditure on
railways, then in their infancy, was less than one
milhon a-year. Even in 1842-43 the capital expendi-
ture was only about 4^ millions ; then in 1846 the
amount authorised by Parliament had risen to 132
million pounds. This actual authorisation of capital
for railways was accompanied by a still greater
amount of speculation. It has been stated that in
1845 — the preceding year — the market value of
the various new schemes which were represented by
letters of allotment was not less than 500 million pounds.
The speculative rise in shares was enormous. In the
Leeds and Thirsk Eailway shares with £2, 10s. paid
rose in a few months to £23, 10s. — i.e., nine times
the value of the amount paid ; in another case shares
with £4 paid in January 1845 were selling at £4, 10s.,
and in September at £42, 15s. — again a rise of more
than nine times. Here again, though the crisis was
commercial in origin, it was in its secondary symptoms
financial. The reserve of the Bank of England was
reduced to £1,600,000, consols fell to 77f , and many
banks failed. In the end the financial , crisis
was stayed by the suspension of the Bank Act of
1844.

I have taken these two crises for illustration,
because the commercial causes in which they originated
were not only perfectly sound, but were destined
ultimately to increase enormously the industrial power
of the nation. The development of machinery, and
the improvement of transport and the means of
communication, were unquestionably two of the

6

74 BANKERS' MONEY

principal causes of industrial progress in the nine-
teenth century.

In a case of this kind, which begins with hond-fide
causes of prosperity, the prosperity passes into
inflation, and the inflation into a crisis, followed by
a depression, simply because speculation, aided by
credit, anticipates too rapidly the realisation of the
future.

§ 11. Similarity in development. — The process after
the preliminary stages is invariably the same. People
begin by investing their money in something which
they think will yield a good return. This is un-
questionably so far legitimate enterprise. There
would be no progress if the owners of capital did
not take a certain risk in new undertakings. The
next step is that the value of the " new thing " —
whatever it is — the value rises. And then people
begin to buy the thing, not with the idea of getting a
good yield from it in the shape of income of some
sort, but of getting an extravagant profit by a further
rapid rise in value. Very soon the original object is
altogether lost sight of, and prices are paid which
under no conceivable circumstances could be justified
by legitimate business. Then the speculation naturally
spreads to other things — many of them hopelessly
unsound from the beginning. If a general speculation
of this kind is aided by a system of credit that is
itself unsound, or at any rate not properly under
control, the inflation is pushed to greater extremes
than would otherwise be possible. Bad speculation
feeds on bad finance. Some speculators, however,
are more far-sighted than others, and some credit

COMMERCIAL CRISES 75

institutions are more prudent with their advances ;
speculation for the fall takes the place of speculation
for the rise ; the fall becomes an avalanche ; good
and bad are mingled together, and the inevitable crisis
is followed by a period of depression of trade and
contraction of credit.

§ 12. The tulip mania. — Economic history is full

of examples of speculation of this kind; sometimes

it is purely local and temporary, at other times it

seizes a whole nation — it may even affect the whole

commercial world; it may be prolonged over a

considerable time, and the collapse, when it occurs,

is all the more redoubtable. Let me recall one or

two famous examples. About the middle of the

sixteenth century a German received a present of

some tulips from Constantinople, and the flower soon

became very popular, especially in Holland. The

tulip was discovered to be capable of great variation,

and especially amenable to artificial cultivation and

experiment. For nearly one hundred years this plant

was cultivated with great success in Holland ; and

the growth of tulips became a very profitable and

highly artistic industry. At last the trade became

too profitable, and the prices of coveted specimens

rose to great heights, and in the year 1634, to quote

the pithy description of an old writer, " the whole

Dutch nation went mad about tulips." Ordinary

trades were neglected for growing tulips ; then people

began buying the bulbs to sell again at a profit ;

prices rose every day, and in the course of a year

specimens of single bulbs fetched £300, £400, and £550.

Then a speculation for the fall began ; roots were

76 BANKERS' MONEY

sold by those who did not possess them, more were
sold than were in existence, and perhaps the first
specimen of a " corner " was when a number of
tulips had been sold of a kind of which there were
only two specimens in the market.

This speculation attracted attention in all the ex-
changes in Holland, the infection spread to other
countries, and large sums were remitted to Holland for
speculation in tulips. At last — but not till 1636 —
prices reached their climax, and a panic ensued on
forced realisations which brought ruin to thousands,
and many years passed before the force of the shock
was spent. Yet even in this tulip mania there was a
basis of reality. The growth of bulbs of all kinds
became an important Dutch industry, and is so to
this day. The interest of the example lies in its a
'priori improbability. The subject of the speculation
is a new kind of flower, and the country that was
afflicted with the mania was the country of the sober-
minded, phlegmatic Dutch.

§ 13. Other speculative manias. — The greatest specu-
lative manias on record, with which the nineteenth
century has nothing to compare, arose in the first
quarter of the eighteenth century — the South Sea
Bubble in England, and the Mississippi scheme and
the speculation associated with the name of John Law '^
in France. The greatest and most picturesque of all
speculators was John Law, and there is little doubt
that he was a man of great financial genius, and that
his schemes, especially his great Bank, only proved

*Tho essay ou " Jolm Law and the Greatest Speculation Mania on
Record," in my Money and MoiiUary Problems (6th ed.), p. 166.

COMMERCIAL CRISES ^^

unsound when they went beyond his own control.
Even the period of the South Sea Bubble saw
the promotion of some of the companies which have
proved the most prosperous of any on record — as, for
example, the New Eiver for supplying London with
water. '

Facilities for speculation in recent times have no
doubt been largely increased by the growth of joint-
stock enterprise, especially after the adoption of the
principle of limited liability. The possibilities of
speculation have been further increased by the
enormous expansion of credit, by the great improve-
ments in the means of communication, by the tele-
graph, and by the extension over a wider and wider
area of dealings, not only on the stock exchanges, but
on all the markets for important commodities. Nor
can we suppose that in the course of two or three
centuries there has been a fundamental change in
human nature ; so far as human nature is concerned,
a South Sea Bubble might begin to-morrow ; the ele-
mentary passions are as strong as ever, including the
love of gain and the love of gambling ; probably,
indeed, so far as the mere desire or the mere greed is
concerned, the passion is at present stronger than in
many former times when speculation became rampant.

§ 14. Ofher causes — Excess of fixed capital. — Al-
though, however, both history and theory point to
excessive speculation as the principal cause of crises,
there are other causes which are too important to be
passed over. The whole of modern industry is ex-
tremely complex, and the various parts are inter-
dependent, and the whole organisation is extremely

78 BANKERS' MONEY

delicate. Accordingly, any great disturbance in the
methods of production, and any dislocation in any of
the parts, may indirectly affect the whole system. A
great conversion of circulating capital into fixed
capital involves a disturbance of this kind. It may
happen that more of the fixed capital is created than
there is any effective demand for, and also that not
enough circulating capital is left for the ordinary
business of the country. In such a case as this, even
if there is no crisis in the sense of a financial panic,
there is a period of inflation, followed by a more or
less prolonged depression. And in all probability this
creation of fixed capital will be accompanied by ex-
cessive speculation in the corresponding companies —
e.g., in railways, mines, or it may be even in land
itself. The present depression in Kussia is due to the
excessive creation of fixed capital, and that in Germany
is also associated with a too rapid industrial develop-
ment.

S 15. Over-production. — Again, there is the
possibility of general over-production in the sense
that markets become over-stocked, production becomes
unprofitable, and labour finds less employment.
Under modern conditions a rise in prices and profits
in any one great industry not only stimulates
production in that industry, but the movement spreads
from trade to trade through the expenditure of the
extra profits and wages, and the whole production of
the country or of the world is carried on at a higher
pressure. Theoretically it may be argued, as by J. S.
Mill, that general over-production is impossible, that
commodities pay for commodities, that the more there

COMMERCIAL CRISES 79

is produced the more there is to exchange. But this
theory implies a perfection in the methods of
distribution or the possibility of exactly adjusting
supply to demand, and of turning capital into
new modes of employment, that does not exist in
practice.

§ 16. Raw materials and the seasons. — A general
cause, which used to be of the first importance, is
found in disturbances affecting the production of raw
material, including food. Under old conditions, when
each country relied mainly on its own harvests, a
series of bad harvests caused universal depression,
except to the farmers, who were more than
compensated by the rise in prices ; and a series of good
harvests caused general prosperity, except to the
farmers, who lost more by the fall in prices. The
influence of the harvest in England used to be so great
that the price of consols was affected by the weather.
Under present conditions the area of supply has been
so extended that the deficiency in one part can be met
by the abundance of another, and in any case so much
is produced, and of such variety, that as regards food,
apart from a general war, there is little fear of any
real scarcity. With regard to raw material of various
kinds there is less room for substitution, and there
may be real scarcity, as we have experienced lately as
regards coal, and formerly as regards cotton. It was
the consideration of the importance of the supplies of
food and raw material which led Professor Jevons to
formulate what is known as the sun-spot theory of
commercial crises — the name is rather startling, but
there is nothing unreasonable in the idea.

8o BANKERS' MONEY

§ 17. The sun-spot theory. — " It seems probable,"
argues Jevons, " that commercial crises are connected
with a periodic variation of weather affecting all parts
of the earth, and probably arising from increased
waves of heat received from the sun at average
intervals of ten years and a fraction." Cycles of
weather of this kind would, of course, greatly affect
the production of raw material, including food products,
and the oscillation between general abundance and
scarcity might, under simpler conditions, very well be
associated with inflations and depressions of trade with
a crisis at a period of transition.

§ 18. Theory of credit cycles. — The periodicity of
commercial crises at intervals of ten years, or at any
rate the regular alternation of inflations and depressions
during decennial periods, has been so marked that it is
natural to look for some very general cause. The late
Mr Mills of Manchester, who was an intimate friend of
Jevons, and well known both as a banker and as an
economist, sought for such a general cause, not in exter-
nal nature in general, but in human nature in particular.
Mr Mills was the author of the phrase " credit cycle,"
and his theory can be best expressed in the biological
language that is at present so fashionable. Mr Mills
made a minute examination of the life history of a
credit cycle, and as he conducted his inquiry just
after the great crisis of 1866, which had followed that
of 1857 after the allotted time, he had very fine
specimens for illustration. His description of a credit
cycle would certainly apply to that period : " During
each of these decades," he says, " commercial credit runs
through the mutations of a life, having its infancy,

COMMERCIAL CRISES 8t

growth to maturity, diseased overgrowth and death by
collapse."

Mr Mills argued that the remedy against the
recurrence of crises was the spread of information,
and just as some diseases are destroyed by light, so
also — this was his main contention — crises may be
destroyed by the light of knowledge and of publicity.
That most solid of all recent works on economics, the
Dictionary of Political Economy^ edited by Mr
Palgrave, seriously asserts that the anticipation of
Mr Mills has been verified in some measure by the
course of events.

This theory seems quite reasonable and even
plausible in itself. Credit depends to a great extent
on confidence, and an inflation of credit involves mis-
placed confidence. It takes time to recover from the
effects of a panic, or even from a narrow escape.
After a crisis business is conducted on cautious and
sound methods — for a time. Then the saying is
verified that John Bull can stand most things, but he
cannot stand two per cent. Two per cent, for the
bank-rate may be quite satisfactory, but two per cent,
for what we have called 'profit-intQrQ^ty and nothing in
the shape of the wages of speculation, this is the two
per cent, against which producers and traders rebel.
They prefer their toil enlivened with a little risk, and
their gains diversified with a little luck. Thus the
period of depression passes into confidence ; the panic
of the past looks less and less black, and the promise
of the future more and more rosy ; and a new period
of inflation is inaugurated.

^19. Im'portance of reference to history. — We are too

82 - BANKERS' MONEY

much inclined to think that this ancient history has
no lesson for us, and that our methods of business are
so sound and so different that all danger of commercial
crises is past. We seem to think that steam and
electricity have not only revolutionised production and
transport, but have also revolutionised human nature.
In sober truth, human nature remains much the same,
and unless our superior knowledge is used to regulate
methods of business, these changes in mechanical
appliances will only give greater opportunity for
mischief. Those who think commercial and financial
crises are things of the past have only to recall the
Baring crisis of 1890. It is quite true, in this case,
that panic was avoided, and that the crisis never
became general, and even the offending firm was
rehabiUtated. But the catastrophe was so near, and
for a time the danger looked so serious, that the
example loses little of its force by way of warning.
It was the practical wisdom, the moral courage, and
the keen sense of public duty on the part of a few
men that saved the situation. I will conclude this
paper by recalling the words used by Viscount Goschen
in a speech at Leeds a few weeks after the danger had
been surmounted. After telhug the audience that we
had only escaped disaster by the skin of our teeth,
he goes on to describe the serious nature of the crisis.
These are the words : *' No fertile imagination could
exaggerate the gravity of the crisis ; and if I attempt
to bring home to those who are listening to me now
the serious nature of the crisis, I do so in order to
accentuate the necessity of their turning their atten-
tion to what I may call the necessity for soundness in

COMMERCIAL CRISES 83

our banking, and soundness in our currency, trans-
actions. I doubt whether the public has thoroughly
realised the extent of the danger to which what is
called the banking crisis exposed us all. It was not a
question of a narrow circle of financiers or traders.
The liabilities were so gigantic, the position of the
house was so unique, that interests were at stake far
beyond individual fortunes — far beyond the fortunes of
any class. We were on the brink of a crisis through
which it might have been difficult for the soundest to
pass unscathed, for the wealthiest to have escaped.
It was a time when none who had liabilities or
engagements to pay could say how they could pay
them if a condition of things were to continue under
which securities could not be realised, under which
produce could not be sold, under which bills could
not be discounted, under which appeared an absence of
cash sufficient to discharge the liabilities of the general
public."

There is but one interpretation of these words, and
that is — that in the opinion of this eminent authority
we were within an ace of a crisis which would have
exceeded in intensity the famous crisis of 1866. At
the same time I have no wish to exaggerate the
possibility of crises or the dangers that may arise
when they do occur. Viscount Goschen spoke when the
danger was hardly past ; but to us it is already part of
ancient history. We can at present afford to be cool
spectators and impartial observers. There could,
however, be no greater mistake than to suppose that
commercial and financial crises are as antiquated as
old machinery; they not only may occur, but it is

84 BANKERS' MONEY

quite possible that for the time being the effects may
be still more disastrous than in former times. All we
are entitled to say is, that, as in the past, these effects
will be obliterated, and commerce will revert to normal
conditions.

PBINTKD BT NULL AND 00., LTD., XDINBUKOH.

MONEY

AND ESSAYS ON

PRESENT MONETARY PROBLEMS

By J. SHIELD NICHOLSON, M.A., D.Sc.

PROFESSOR OF POLITICAL ECONOMY IN THE UNIVERSITY OF EDINBURGH

Sixth Edition, Revised and Enlarged.
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HISTORICAL PROGRESS

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